2017: The revenge of Eurozone markets?
Since the euro crisis, US stocks staged almost twice as much performance than Eurozone equities. Will Eurozone markets start taking revenge in two thousand seventeen? We believe it’s time to reconsider this issue.
To be sure, political uncertainty appears higher in the Eurozone. The Union is facing a heavy agenda with elections in Netherlands, France, Germany and possibly Italy, not to mention the Brexit negotiations.
However, policy risks seem well reflected in less demanding valuations. The Eurozone trades at a discount of about 15% relative to the US on a forward PE ratio basis. And the discount increases to almost 50% on a price to sales or price to book bases.
Also, dividend yields are more generous in the Old continent and sentiment has more room to improve. But will it be enough to fuel a lasting catch-up? Probably not.
We believe that the decisive factor should be earnings growth. We doubt consensus forecasts that show similar progress, in a 12 to 15% range. Our models do suggest similar top-line growth, at about 3%, but margins should make the difference.
In the US, mounting wage inflation and higher interest rates would reduce after-tax margin by three quarter percentage point and lead to a 2% decrease in EPS. Factoring-in a fully retroactive tax reform would morph the 2% decrease into an 8% increase. This is still below the consensus view.
By contrast, in the Eurozone, operating leverage combined with a slight improvement in corporate pricing power should add at least 0.5 percentage point to margins, which could translate into EPS growing 10 to 15%.
We expect more volatility in the coming months and recommend tactical calls to address the theme.