Can European Stocks Continue to Outperform their U.S. Peers?

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In an article in December last year I wrote why U.S. investors may want to diversify by holding foreign stocks. Quoting from that piece:

For example, though the U.S. stocks have done very well in 2013 and this year, there is no guarantee they will continue to outperform other markets in the future. No country has been the top performer consistently every year as shown in the following Periodic Table of Investment Returns for Developed Markets 2013:

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So it turns out that European stocks have outperformed U.S. stocks at least so far this year. We will have many months to go.Hence we cannot predict if this trend will continue thru the rest of the year.

The question on some investors’ mind is if European stocks can maintain their current bull run.

According to a research report by Thornburg Investment Management, U.S. stocks and their European counterparts have taken turns in outperforming each other in the past. The following table illustrates this fact using the S&P 500 and the MSCI EAFE Index:

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SP500 vs MSCI EAFE performance

By moving into attractively valued stocks with more upside potential, there’s also more downside protection, as Benjamin Graham’s “margin of safety” precept has long suggested. This common sense investment principle may be why the S&P 500 Index and the MSCI EAFE Index have taken turns outperforming each other over the last four-and-half decades. So while the S&P 500 beat the MSCI EAFE by 58% from November 30, 2007, through October 31, 2014, the MSCI EAFE outperformed the S&P 500 by 60% over the preceding seven years (Figure 2).

Though past performance does not predict future results, in the period from 2000 to 2007 the MSCI EAFE had a strong run beating the S&P 500.

At end of 2014, European stocks were trading at very cheap levels compared to American stocks. However with the current rise of European equities they are not very cheap now but there is still room to grow.

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CAPE Ratio-Europe vs US

NOTE: The above chart is based on data as of 12/31/14.

Source: Margin of Safety:Tactical Rebalancing and Strategic Allocation in Overseas Equities, Feb 2015, Thornburg Investment Management

The key takeaway from this post is investors need not dump their European holdings now.Rather they can wait for additional growth as the ECB’s stimulus program has just started. Also any new investments can be made very selectively in a phased manner.

Related ETFs:

  • SPDR S&P 500 ETF (SPY)
  • SPDR STOXX Europe 50 ETF (FEU)
  • SPDR DJ Euro STOXX 50 ETF (FEZ)

Disclosure: No Positions

Share of World GDP since 1980

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The U.S. share of global economic output continues to decline. Last year it stood at just 22% of the world GDP while the share of emerging economies is growing. This is another reason for U.S. investors to diversify and include foreign stocks in their portfolios. Currently most U.S. investors have low allocations to international stocks due to the effect of “home bias”.

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Share of World GDP since 1980

Source: Margin of Safety, Tactical Rebalancing and Strategic Allocation in Overseas Equities, Feb 2015, Thornburg Investment Management

From the research report:

Although the United States still boasts the globe’s biggest economy and deepest capital market, the world has rapidly evolved over recent decades. Back in 1970, the U.S. share of global stock market capitalization stood at a towering 66%, according to MSCI. At the end of June 2014, its share amounted to just under half the total. Meanwhile, the U.S. share of global economic output stood at 26% in 1980, while that of emerging markets and developing countries was 25%, and China’s just 2.8%.3 Fast forward to 2014, and the U.S. share has shrunk to an estimated 22%, while emerging markets and developing countries now account for some 39% of world gross domestic product, and China’s economy has since grown almost five-fold to 13% of global GDP (Figure 3).

The entire report is an interesting read.

Three Reasons Why European Dividend Stocks are Attractive Now

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European equity indices have outperformed their American peers so far this year unlike last year when the S&P 500 was the winner. Compared to the S&P 500’s year-to-date return of -0.9% as of Mar 11th, the returns of major European indices are listed below:

UK’s FTSE 100: 2.4 %
France’s CAC 40: 17.0 %
Germany’s DAX Index: 20.4 %
Spain’s IBEX35 Index: 7.2%

Since European stocks have already run up substantially relative to U.S. stocks, some investors especially income investors may be wondering if they want to get into European stock at current levels. The answer to that question is a big yes. Despite the current rise, many markets in Europe offer attractive investment opportunities. For dividend investors Europe is still a fertile hunting ground. In this post let me list three solid reasons to invest in European dividend stocks now:

1. The gap between dividend yields of stocks and the yields on government and corporate bonds is very wide. Historically this gap has not been this wide according to a research report by Allianz Global Investors.

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2. European firms pay high dividends compared to other regions of the world as shown in the chart below:

European stocks Div Yield vs Other Countries

The average dividend yield stood at 3.3% at the end of 2014 based on MSCI Europe.The US dividend yield is in the 2% range. Outside of Europe, Australia and New Zealand companies also have high dividend payouts.

Source: Dividends instead of low interest rates, March 2015, Allianz Global Investors

3.European stocks have still room to run according to Nicolas Simar, head of the Equity Value Boutique at ING IM. From an article by Mr.Simar in Investment Europe:

Prices of European equities have yet to fully reflect the ECB’s QE and corporate margins should improve this year due to accelerating global economic growth, which should generate higher dividends. European earnings are still 30% below their previous peak in 2007 while US earnings are 20% above theirs: this gap will close as the ECB remains accommodative and the declining Euro boosts exports and adds to top-line growth.

Another gap set to close is that between the real yields of European equities (3.3%) and German Bunds (0.39%), which is around 90% of the peak seen in September 2008. ING IM believes there are still opportunities to exploit this gap before it narrows.

Selected Cyclical stocks are particularly attractive after their poor performance in 2014 depressed market expectations to the point that some of them are now priced for a recession.

Source: ING IM: European dividend stocks offer buying opportunity in 2015, Mar 12, 2015, Investment Europe

Ten dividend stocks from ten countries on the continent are listed below for further research:

1.Company: Nordea Bank AB (NRBAY)
Current Dividend Yield:  4.55%
Sector: Banking
Country: Sweden

2.Company: Edp Energias De Portugal SA (EDPFY)
Current Dividend Yield: 7.06%
Sector:Electric Utilities
Country: Portugal

3.Company:Diageo PLC (DEO)
Current Dividend Yield: 3.03%
Sector: Beverages
Country: UK

4.Company: Nestle SA (NSRGY)
Current Dividend Yield: 3.20%
Sector: Food Products
Country: Switzerland

5.Company: BASF SE (BASFY)
Current Dividend Yield: 4.00%
Sector: Chemicals
Country: Germany

6.Company: Total SA (TOT)
Current Dividend Yield: 6.52%
Sector: Oil, Gas & Consumable Fuels
Country: France

7.Company: Royal Dutch Shell PLC (RDS.A)
Current Dividend Yield: 6.40%
Sector: Oil, Gas & Consumable Fuels
Country: The Netherlands

8.Company: Telefonica SA (TEF)
Current Dividend Yield: 6.27%
Sector: Telecom
Country: Spain

9.Company:Telenor ASA (TELNY)
Current Dividend Yield: 6.21%
Sector: Telecom
Country: Norway

10.Company:Enel SpA (ENLAY)
Current Dividend Yield: 4.06%
Sector: Electric Utility
Country: Italy

Note: Dividend yields noted above are as of Mar 12, 2015. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure: No Positions