Money has been piling into European shares as fears of the euro imploding recede, the economy shows signs of life and investors look for the next trade after Japan.
But the “eurozone shares are cheap” theme might have run its course. This chart shows the discount of eurozone forward price-to-earnings compared to the US, as a percentage (using MSCI indices).
The eurozone discount is right the way back down to the levels which applied pre-crisis, and were briefly reached in the summer of 2010 (remember that time when Brussels thought the eurozone had been fixed and everyone focused on the next US recession?). They are also lower than the average discount since 1999, when the euro was created.
Eurozone shares are still at a big discount to the US, of course, with every sector apart from technology and healthcare cheaper in Europe on both forward PE and price to book. But Europe almost always trades at a discount to the US, thanks to the less-developed equity culture, less shareholder friendly approaches to corporate governance and governments more willing to tinker.
Time for the macro tourists to move on.
The bonus table today comes from Dhaval Joshi at BCA Research, looking at the cyclically-adjusted PE ratios. Macro tourists usually ignore these, but for investors they’ve provided pretty much the only guide to long-term returns (although no guide at all to short-term returns).
Caution is warranted. CAPE is based on comparing price to 10 years of earnings to try to smooth out the profit cycle, and long histories are hard to compile outside the US. Also, it is entirely plausible to argue that Greece is one of the places where things really are different this time: the country has been downgraded to an emerging market, is still in a long-running depression and has an unsustainable level of government debt.
Is it really right to think overall earnings from Greek listed companies should be compared to those of the past 10 years, now the banks have all but vanished? Investors who use CAPE like it precisely because it smooths out the ups and downs of the cycle, and it is always hard to believe when times are tough that they will ever be good again. That creates bargains when everyone can see good reasons why things will never return to normal – and Mr Dhaval, along with lots of hedge funds, thinks Greece is a bargain at the moment.