Mean Reversion, or Extreme Aversion?

You may have heard me banging on (with my view) that there really isn’t a massive difference between the quality or opportunities of most listed securities in Europe and the US. Sure, the tech stocks are better in the US (ASML and ARM notwithstanding), but the luxury goods names in Europe are better (notwithstanding no one, as Tiffany’s is now part of LVMH). Broadly, these are similar, multinational businesses (think Nike and Adidas, or Nestlé and Mondelēz, or Boeing and Airbus) that sell similar products at similar price points in similar geographies. Sure, there are idiosyncratic differences between each company, but they have little to do with geography, culture, or the political climate of the country where they are located or listed.

And we have shown that for the thirty years from 1980 to 2010, there was little difference between the performance of the stock market in either region. During this period, the S&P 500 generated total returns of 2,524%, while the MSCI Europe generated 2,515%. And this all made good sense.

In terms of annualized returns over this period, they looked like this:

Not a whole lotta difference.

And we’ve also written about the disconnect between the two markets since then.  I’m not going to get into the specifics of “why” in this piece, and folks a lot smarter than me have taken a stab at this one too. I will only point out here that the US outperformance is continuing (so far) into this decade. Since the beginning of 2010, the total return of the MSCI Europe is 175%. During that period, the S&P 500 is up 550%.

You read that correctly.

Can this outperformance last forever? Maybe. But as you might have guessed, we won’t be surprised if it doesn’t. And when we take a step closer and look at some specifics of what is driving this phenomenon, we see that a portion of the outperformance of the US over Europe during the last four years, specifically, has been driven by multiple expansion. US stocks now trade at roughly a 50% premium to Europe.

At the end of 2020, the S&P 500 traded at 27.0x forward earnings, and the Russell 1000 traded at 28.2x. Simultaneously, the MSCI Europe traded at 22.8x, and the Eurostoxx 600 went for 23.5x.  Those were basically 18-20% premiums of the US over Europe. Okay, fine. European indices have more banks and utilities and less tech exposure, so fine.

But in the past 3 ½ years, that premium for US names has blown out to over 50%.

‍And if you want to guess what drove that, you might be surprised.

In terms of the subsets of value and growth stocks within each index, this one will make you scratch your head.

You might think that it’s the outperformance of growth stocks in the US have driven this relative multiple expansion over Europe. I mean, it has a little bit, but not nearly by what you might have expected.

In 2018, US growth stocks traded at an 11% premium to European growth stocks.  Today, despite the Nvidias and their ilk, that figure has only increased to a 22% premium for US names.

So where have things gone wild?  In Valueland, that’s where. In 2018, “value” stocks in the US traded at a 24% premium to their European counterparts. Today, that figure is over 90%.

In other words, it is the value stocks in Europe which have been hit the hardest. Harder than the growth stocks, and even harder than US value stocks. Much harder, in fact.  Here is the data in table form.

Looking at the two “factors” together, you can really visualize the relative impact on the pricing of value stocks vs. growth stocks in both regions.

In our view, it is possible that European value stocks have been broadly ignored (even more than US value stocks), or suffered from relative illiquidity, or extreme risk aversion, or just haven’t had the same forces driving their current valuations.[1]

If and when this current dynamic changes – and judging by the performance of these markets from 1980 to 2010 – well, we’ll just have to wait and see.[2]