European indices have handily outperformed their US counterparts over the last six months. Nevertheless, the valuation gap between the two regions remains wide, suggesting Europe should continue to outperform in coming years. That’s according to Boston-based Verdad Research, which notes Europe trades on a cyclically adjusted price-earnings (Cape) ratio of 20.4 versus 28.2 in the US.
Europe has generally traded at a discount to the US, but today’s valuation gap is especially notable – it’s nearly double the average historical discount over the last four decades. Today’s reading is wider than 76 per cent of instances since 1981. Yes, it has narrowed since October – that reading ranked in the 95th percentile of recorded history – but the gap remains wide.
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Sceptics will say Europe is cheaper for good reasons, but Verdad says wide valuation gaps have historically presaged high future returns. It notes that over four separate two-year periods, beginning in September 1992 and June 1996, 1999, and 2003, Europe outperformed the US by an average of 5.7 percentage points annually, as valuation spreads gradually narrowed.
We are likely to be in the early stages of another such period, says Verdad, indicating Europe should continue to outperform the relatively expensive US market in coming years.
