Much has been made of Europe’s impressive market performance last year (and ongoing this year) with its strength yet another confirmation-bias proving indication that every US stock dip should be bought. In recent days a few cracks in the armor of European invincibility have begun to show as political and banking system fraud comes back top haunt along with rising concerns and jawboning about the strength (or lack thereof) of the Euro. With a somewhat split view of Thursday’s ECB meeting (will Draghi cut to hold EUR down for exports or hold to maintain the optics of a strong EURUSD meaning a strong Europe), it is perhaps notable that the outlook for 2013’s GDP growth continues to sink. However, as the chart below so obviously highlights, expectations for earnings growth in Europe have massively disconnected from macro fundamentals (just as in the US) as nominal stock indices is all that matters anymore.
European Stock EPS Growth expectations vs GDP growth expectations for 2013…
Notice the disconnect really began when the ECB went ‘extreme’ with LTRO – and never looked back. Will the current payback of LTRO bring reality closer?
As BNP notes (advising clients to short Europe),
Fade to Fundamentals? Europe still needs to substantially deleverage and is in the midst of a recession. Investor focus should fade back to these still concerning fundamentals. Positive economic surprises are unlikely to catch up with market expectations for growth.
European Misses More Likely: Despite substantial foreign revenues, it is rare for an equity market to manifest double-digit EPS growth while the underlying domestic economy is in recession. This current contradiction is almost always resolved in favour of the economists.
Euro losing the Currency War. The trade weighted Euro has risen by 12% since last July. In addition, the Euro rallied by 32% against the JPY over the past 6 months driven by part by “Abenomics” politics in Japan and the 200bn LTRO repayment contracting the ECB balance sheet driving up European rates. Europe is therefore becoming less competitive relative to other regions.
Not Cheap. On sector adjusted valuations or free cash flow yields, Europe looks expensive. The US however appears cheaper than implied by headline P/E given “Equity Easing” through share buyback and distortive effects of cash on balance sheet (cash P/E>100x).
Perhaps, that is what credit markets are so concerned about (as well as Bail-Ins)…