In recent years the S&P 500 has outperformed its European counterpart, the STOXX 600. What does 2020 hold for markets on either side of the Atlantic as the coronavirus storm hits?
In the three years to 13 March, the S&P 500 had returned 14.2%, while the Stoxx Europe 600 has dropped by 20%.
According to JP Morgan, there are two sectors behind the S&P 500’s success – namely, technology and financials. “From 2017 to date, when US tech stocks have soared and European financials have sagged, these two sectors alone have driven over three-quarters of the US market’s overall outperformance,” the bank’s global market strategist Hugh Gimber commented.
Stoxx Europe 600's 3-year drop compared with S&P 500's 14.2% rise
The seemingly never-ending saga of Brexit has also weighed heavily on stocks throughout the UK and the on the continent. However, with the recent bearish moves in the US, ending a record 11-year bull market, and as COVID-19 wreaks havoc both in Europe and in the US, how may the relative performance of the S&P 500 and Stoxx 600 change?
Big movers and losers
According to Alberto Tocchio, chief investment officer at Colombo Wealth, the S&P 500 has been moved upward mainly thanks to five key stocks – Apple [AAPL], Microsoft [MSFT], Amazon [AMZN], Alphabet [GOOG] and Facebook [FB]. In January, together they accounted for approximately 19% of the total S&P 500 index in terms of weighting.
“The US is still the reference for global investors with a strong concentration of technology and FAANGs,” he tells Opto. “Europe is skewed towards value stocks, such as financials and auto. It lacks growth stocks.”
Artur Baluszynski, head of research at Henderson Rowe, agrees. He suggests that this composition has also made Europe more vulnerable to the coronavirus pandemic. “In terms of how the indices are built, there are more heavy manufacturing, low-return-on-equity stocks in Europe which are exposed to Asian economies,” he explains. “In the US, there are more technology-based stocks with high ROE. This means that Europe gets hit really hard by events such as the slowing Chinese economy in 2019 or the coronavirus crisis.”
“In the US, there are more technology-based stocks with high ROE. This means that Europe gets hit really hard by events such as the slowing Chinese economy in 2019 or the coronavirus crisis” - Artur Baluszynski, head of research at Henderson Rowe
He believes that this “natural imbalance” between the two indices will only become more pronounced as a result of the current global health crisis.
“China may be the first economy out of the current problem. When its supply chain jump starts, it might be good news for European luxury goods makers, consumer giants like Unilever [ULVR], value added component and automotive manufacturers,” he says.
However, he notes that European indices only have about 15% exposure to China. “The majority are European banks and financial institutions which, with Italy, Spain and other countries likely in a recession, will drag indices down. US tech and domestic businesses valuations, unless there is a very negative coronavirus led economic contraction and repricing, should withstand it,” he considers.
US vs European indices: Looking ahead
According to Refinitiv, the forward price-to-earnings ratio for the broad Stoxx 600 index is 15.4, well below the 19.3 forward P/E of the S&P 500. Baluszynski doesn’t see that changing anytime soon.
“Some people say that there is more downside to come because of the valuation levels compared to European indices but the US has higher quality components than Europe and deserves that premium. The valuation gap will continue,” he declares.
Tocchio describes European equities as being “cheap, unloved and oversold”. He says utilities, commercial services and pharmaceuticals are overvalued while consumer services, energy, banks and automotive stocks are relatively undervalued.
“Valuations look very attractive here with MSCI Europe forward 12-month P/E at 10.5X, more than 20% below the long-run median level of 13.5X. If we assume that MSCI Europe fair value is set at 13.5X, then earnings should take a 20% hit on average, too much from our point of view. We believe that US Equities will be the main driver leading to a global rebound,” he adds.
“If we assume that MSCI Europe fair value is set at 13.5X, then earnings should take a 20% hit on average, too much from our point of view. We believe that US Equities will be the main driver leading to a global rebound” - Alberto Tocchio, chief investment officer at Colombo Wealth
The European opportunity
Despite the weaker outlook, however, analysts aren’t saying that investors should give up on European equities entirely.
Adrian Lowcock, head of personal investing at Willis Owen, says a virtual guarantee from the UK government to support every business from the impact of the coronavirus will help shore up confidence. “You look for companies with steady and predictable income streams and oil majors like BP [BP] and Royal Dutch Shell [RDSB] which have been through this kind of volatility before,” he explains.
“In airlines, EasyJet [EZJ] could be the last man standing after the crisis as bankruptcy or consolidation takes over in that sector. In retail, we will see an accelerated shift to online from traditional bricks and mortar, so a stock such as clothing group Boohoo [BOO] will see business interrupted but not be broken.”
Despite this, Baluszynski still believes that US markets will emerge from the crisis quicker than Europe. “The US can get its act together quicker because it doesn’t have 27 bureaucratic European countries each having to agree on regulations and emergency measures,” he says.
“If the West can contain the virus in the next three months — so the beginning of June — then markets will discount that very quickly and [there will be a] rally. But if it is not contained and there is a huge negative impact on the economy, then the S&P could fall by another 20%. I expect we will see something in between with some good news in the summer around vaccines or containment timelines. The markets want that good news and then will discount very quickly.”
“If the West can contain the virus in the next three months — so the beginning of June — then markets will discount that very quickly and [there will be a] rally. But if it is not contained and there is a huge negative impact on the economy, then the S&P could fall by another 20%” - Artur Baluszynski