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JP Morgan: Europe Equities Expensive, More QE To Come?
Aspire, Investments | 21 April 2015
By: Lim Si Jie
Articles (169) Profile

The Euro Zone continues to stumble along with one percent Gross Domestic Product (GDP) growth. Although Germany is doing well, Italy and Greece are suffering from negative growth. In addition, GDP growth trends in France, Italy and Spain are at the lowest levels of the last century.

Yet surprisingly, analysts and investors (including Warren Buffett) are still quite optimistic on the region’s future. They have been predicting an earnings recovery that has not happened.

Flat Trend In Earnings And RoE

Flat trends in European earnings stand in stark contrast to growing US earnings. The weakening of the Euro certainly does not make that chart look any better. To top it off, it is not just earnings growth which lags in Europe, but Return on Equity (RoE) in Europe is also lower as well.

European Equities Remain Expensive

JP Morgan observed that since averting sovereign and bank default, “equity and credit valuations have returned to pre-crisis levels.” Credits that were spread across bank and sovereign debt are tight across the curve and across countries. The P/E discount for European and Euro Zone equities relative to the US is still quite tight.

Unless there is “substantial re-acceleration of European profit growth compared to recent trends,” JP Morgan will continue to hold the view that European equities are expensive. Investor sentiment might improve on the back of European Central Bank (ECB) purchases of sovereign bonds, but that will further drive the relative P/Es higher in the absence of actual earnings improvements.

Optimism Priced Into European Equities

Despite almost no improvement in industrial production or earnings in the last two years, French P/E multiples have risen back to pre-crisis levels.  Financial markets are optimistic and assuming that France will find a way to start growing at a faster pace.

Credit Loosening To Drive Demand?

JP Morgan notes that there are still signs that growth will improve in 2015 compared to 2014. Although the Euro has weakened, credit loosening has made bank loans easier. Furthermore, there is also less drag from fiscal austerity and EU should benefit from lower fuel prices. As a result, towards the end of 2014, there were first signs of positive European credit demand since 2011.

While European banks are seeing increases in domestic loan demand, they may face problems extending loans to commodity exporting countries. Spain has large exposures to Brazil, Chile and Peru while Italy and Austria are among countries with the largest banking sector claims on Russia.

What Happens If Europe Doesn’t Grow?

If European growth falters in 2015, the ECB may have to be more aggressive if it wants to make an impact. The scope and breadth of assets purchased by the ECB are considerably smaller than those purchased by the US Fed.

European central bankers are debating Quantitative Easing (QE), a policy that would give the ECB the latitude to buy sovereign debt.  Given how tight credit spreads are, JP Morgan remains sceptical on the effects of a large scale QE. However, the initial market reaction “would probably be positive.”

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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