Is Europe a Good Place to Hide in a Stock Market Correction?

(Bloomberg) -- With global stocks looking increasingly ripe for a pull-back, one corner of the market that has been spared the euphoria could show resilience in a correction: Europe.

As equity markets worldwide enjoy a brisk start to the year, investors and analysts have not been embracing European equities with the same zeal as other major developed and emerging markets, indicators including relative strength indexes and the pace of earnings upgrades show. That means the region could be less vulnerable when the long-awaited correction comes.

The fundamentals for an equities rally in Europe this year are firmly in place: Germany, the region’s largest economy, is enjoying an economic boom amid the broadest euro-zone expansion in almost two decades. At the same time, valuation ratios show European stocks remain relatively cheap compared with frothy U.S. levels.

Here are five charts showing an absence of investor exuberance for European equities and the macroeconomic backdrop speaking in their favor:

The Euro Stoxx 50’s relative strength index, a momentum indicator that tracks the magnitude and speed of price fluctuations, is the only one among major markets not in territory considered overbought.

Cross-asset strategists at Morgan Stanley raised their suggested exposure to European equities by one notch and lowered their stance on U.S. equities in a note on Tuesday, saying the latter’s recent outperformance leaves limited upside, while the backdrop for European stocks’ outperformance is intact.

After years of crisis, Europe’s economy is finally gathering steam, with data on Tuesday showing joblessness in the euro area declining to the lowest level since early 2009.

“In Europe, the combination of easy credit conditions and falling unemployment should support confidence, earnings and equities,” Mike Bell, a global market strategist at JPMorgan Asset Management, said at a briefing in London. “An incredibly tight correlation has existed throughout history whereby rising consumer confidence in the euro zone boosts equity prices, and you get this virtuous cycle. We think that will continue.”

While a Citigroup Inc. index tracking earnings revisions in Europe is at the highest level since last May, that’s nowhere near the level of enthusiasm for global profits. Analysts who raised profit estimates for companies around the world last week outnumbered those cutting them by the biggest margin since Citigroup began compiling the data 18 years ago. The relative caution on Europe may harbor some upside given the brisk economic growth as well as U.S. tax cuts, which should also be a catalyst for many European companies.

Valuation measures also show striking differences between the momentum of U.S. and European stocks: While the S&P 500 trades at 18 times expected earnings in the next 12 months -- a level not seen since 2002 -- the Stoxx 600’s price to earnings ratio, at 15, remains below its peak of 2015.

The gap is even wider when it comes to price-to-book ratios. The Stoxx 600 trades at 2 times book value, not cheap in absolute terms. But with the S&P 500 trading at 3.4 times book value -- the highest level since 2002 -- the spread between the two indexes’ ratios is the widest since Bloomberg started tracking the data in 2002.

“There’s definitely less euphoria in European stocks at the moment,” says Andrea Tueni, head of sales trading at Saxo Banque France. “Now the big question is: will European stocks be immune if there’s a correction on Wall Street?”

To contact the reporters on this story: Blaise Robinson in Paris at brobinson58@bloomberg.net, Aleksandra Gjorgievska in London at agjorgievska@bloomberg.net.

To contact the editors responsible for this story: Celeste Perri at cperri@bloomberg.net, Angela Cullen

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