Cheap or not?
But are European equities really that cheap? The answer is that, on a fundamental basis, they aren’t. European forward P/E ratios are slightly above their long-term average. However, on a relative basis the lights are still green.
Compared to US equities, European stocks are still cheap from a valuation perspective. But it’s the ECB’s monetary policy makes the asset class especially appealing. “Because interest rates remain so low, Europe is still cheap on a relative basis, looking at interest rates versus dividend or earnings yields,” says Vergote.
The improving macroeconomic outlook in Europe will not tempt the ECB to tighten its monetary policy any time soon, Vergote believes.
“Core inflation remains well below the ECB’s target of 2% and unemployment in countries like France, Spain and Italy is still far too high. For the rest of 2017, monetary policy will therefore remain accommodative, and European equities will remain attractive. But that might change in 2018 if the ECB starts to tighten.”
It’s not about France
The perspectives for European equities will of course reverse drastically if Marine Le Pen manages to pull off a surprise victory in the second round of the French presidential elections on 7 May. Even before Sunday’s first round, most analysts assumed that markets had priced in a Macron victory. That was obviously not the case, but it probably is now.
Even if the consensus view prevails and investors’ preferred candidate Macron wins, he will probably have a hard time implementing any meaningful economic reforms. Macron, who has never before been elected to political office, faces the formidable challenge of assembling a majority in parliament after elections scheduled for June. And that will be a pretty complex task considering his lack of grassroots support and political experience.
We may therefore well be in for another five years of frustrating inertia in French politics. But markets haven’t rallied because they expect Macron to reform France.
They rallied because they consider Sunday’s election result a boon for political stability in Europe. A disorderly break-up of the EU and the euro is now considered very unlikely to happen, at least over the next five years. And that’s being reflected in market sentiment.