Are Europe's Equities Really a Bargain?

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 |  Includes: DIA, QQQ, SPY
by: James Picerno

Now that volatility has returned to the global capital markets, an inquisitive investor might reasonably ask: What's volume done for me lately?

It's a good question, and it's one that this writer routinely asks as an input for weighing global equity diversification. In search of an answer, or something approximating one, we turn to the numbers. As a preview, Europe looks intriguing, at least on a relative basis, or so the November 30 data from S&P/Citigroup Global Equity Indices suggest.

Let's begin with the dividend yield. As the table below shows, Europe's trailing 3.17% boasts the highest yield among the major regions of the world. Relative to what you'll find in, say, the United States (1.7%), three and change looks pretty good. There's no guarantee that a relatively high yield will translate into superior total return performance in the future, although it helps tip the odds a bit.

The Europe story looks even better by way of price/earnings ratios (P/E). On a trailing 12-month basis, the Continent's equities change hands at the lowest P/E among the world's major regions, as our second chart below reports. Europe's 13.3 P/E compares favorably to the relatively expensive 16-plus in the U.S. and Japan.

What's more, earnings projections for the world's stock markets also give Europe the edge. The IBES near-term projection shows Europe's forward-looking P/E at the same level as its trailing P/E. In both cases, that's the lowest in the world on a regional basis, as we define regions in our charts.

Rest assured, Europe has "issues" that may give investors pause. For starters, the euro's value against the dollar has been soaring of late, which makes the region's exports more expensive (i.e., less competitive) in dollar terms. In addition, the euro area's workers are aging faster compared with the labor force in America's, suggesting to some that the growth prospects are stronger in the U.S.

Admittedly, P/E ratios and dividend yields are only two measures of investment opportunity. Indeed, Europe's yield and P/E look attractive in part because the Continent's equities lost the most ground last month relative to the world's other major regions. In addition, Europe's performance this year through the end of November looks middling, which has driven up valuations at a faster pace in markets outside of Europe's leading markets. Then again, lower prices imply higher prospective returns.

All of which suggests that Europe may be worthwhile as an overweight in a globally diversified portfolio. For perspective, Europe currently represents roughly 30% of the planet's available equity capitalization, as per S&P/Citigroup numbers. The question is whether it deserves a bit more?

Maybe, although keep in mind that 30% is just about Europe's highest share since the mid-1990s. In other words, Europe's already had a good run in terms of grabbing a bigger slice of global equity capitalization. That's not to say that it can't keep running, but there are limits, and much of that has to do with growth. And as the planet's outlook for long-term earnings growth goes, Europe probably ranks average, at best.

Nonetheless, we're inclined to keep a market weight for the Continent. We're more inclined on a tactical basis to trim weights in the red-hot emerging markets, although that would indirectly boost Europe's influence in a global equity portfolio.

In short, we're still not convinced this is a moment for major changes in asset allocations. But that's today. In a time of transition, opportunity and risk can shift quickly and dramatically. Stay nimble, stay prepared and keep a cash stash on hand.