Home tech European equity markets are suffering, and there is no Facebook or Microsoft...

European equity markets are suffering, and there is no Facebook or Microsoft in sight

A flag of the European Union flies in front of the Parliament in London. Brexit will be a major concern until the March 31 deadline.

Daniel Leal-Olivas / AFP / Getty Images

The European actions are certainly not the things to bring up the animal spirits of an investor. Maybe it's just a bias from the New World, but I can not think of a CEO or European company that could be called transformative in the way of Zuckerberg or Tesla. (Can you?) The European exchanges do not boast among their lists of fantastic FAANG or of famous entrepreneurial prodigy. For comparison purposes, consider that the three largest companies in the United States by market capitalization are Microsoft, Amazon and Apple. The three big ones on the MSCI Europe index, out of 439 constituents? Nestlè, Novartis and Roche: all excellent international conglomerates, granted, but, well, not really revolutionary. By the way, Microsoft's market capitalization, equivalent to about US $ 822 billion, is higher than that of the top three combined European equities – and you can throw the fourth, HSBC, and you still can not get it.

Well then? From an investor's perspective, boredom can be good, even though growth stocks have captured newspaper headlines and most of the gains in recent years. But now, with the FAANG assaulted by regulators, apparently everywhere and the resulting flowering has grown with the end of the (perhaps) looming economic cycle, could old Europe tarnish an intelligent diversification game for North American investors?

From a pure valuation perspective, European equities appear to be of great value compared to their US counterparts. At the end of last year, the price / earnings ratio of the MSCI Europe index has hit a five-year low, and today stands at 14.88 over a 12-month period, compared to 20 for the S & P 500. Even on a forward basis, the difference is still there, with European equities valued at 12.6 times forward profits and the S & P 500 rated at 16 times. The other thing about European equities is that they pay dividends. The dividend yield of the MSCI Europe index is 3.8 percent, against just two percent of the S & P 500.

The price / earnings ratio is a fairly simple tool for measuring value, particularly when applied to a complex market such as the European one. The risks – many, but not all, politicians – certainly seem large enough to transform what might seem like a valuable game into a value trap quickly enough.

We saw that movie before, and not so long ago. The European markets started 2018 in a rather bullish state, partly because, as now, they seemed cheap. The Euro Stoxx 600, a total market index of large, medium and small capitalization companies, reached its all-time high in January. But around June, the wheels started to break away and by the middle of December the index had dropped by about 18%.

At least part of the decline stemmed from concerns about global economic prospects, triggered by US-imposed tariffs on Chinese goods. The European economy is heavily dependent on trade: it includes almost 90% of GDP in the euro area, compared to about 30% of GDP in the US Like stocks closer to home, Europe has recovered from these lows even when hopes have increased for productive trade talks between the United States and China.

But not everything that sucks European stocks can be placed at the doors of the Trump tariffs. The consequences of a tough Brexit would be felt across the continent. Italy, whose economy could be reduced this year, is heavily into debt under its populist government, threatening to further undermine the European Union. France is grappling with yellow jackets and Germany, the economic power of Europe, has seen industrial production decline for the fourth consecutive month in December. In addition to the March Brexit deadline, there are the European Parliament elections in May, as well as the potentially divisive votes in Spain and Sweden.

The first half of this year could determine the prospects for global trade, depending on the outcome of the U.S.-China negotiations.

Meanwhile, the European Central Bank has halted its quantitative easing program in January – for the first time in four years. But the ECB also reduced its growth prospects for 2019 (to 1.7 percent) last December, and some of the more hawkish members of the board, such as Klaas Knot from the Netherlands, have recently started to send accommodating signals. This suggests that the path to standardization is not yet clear in Europe – and the last month's QE stoppage could only end in a break.

This would probably be welcomed by the equity markets. The biggest question is whether investors can start looking beyond the multiple downside risks. If they are about to materialize, it should be as soon as possible. The first half of this year could determine the prospects for global trade, depending on the outcome of the U.S.-China negotiations. The expiry of the Brexit is fast approaching and even an extension will probably be considered good news for the stocks. As for the elections, well, even populists can lose.

In short, we do not know if the risks in Europe have worsened as they are going. But if they do not get worse – and we might know in the coming months – then perhaps European equities will really be the value they seem to be.

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