U.S. stocks are currently commanding higher valuations than their European counterparts. The SPDR S&P 500 ETF Trust with a forward P/E ratio of 21x is 50% pricier than the SPDR EURO STOXX 50 ETF.
Bank of America analysts, Ohsung Kwon and Savita Subramanian, shed light on the apparent disparity in valuations. They stated that while the S&P 500 may seem exorbitantly valued compared to Europe initially, the whole story reveals a different narrative.
Upon deeper analysis, the premium attached to U.S. stocks over European equities appears more nuanced. Accounting for sector allocations, growth prospects, energy security, and the potential from AI investments, the premium becomes reasonable.
The analysts pointed out that a significant portion of the S&P 500’s valuation premium can be traced back to its heavier weighting in asset-light sectors like Technology. Adjusting for this discrepancy reduces the premium to a mere 12%.
This adjusted premium is closely linked to the growth differentials between the U.S. and Europe. The current 12% premium suggests that the U.S. economy is anticipated to outperform the European economy by 2.6 percentage points this year.
Factors such as energy security and geopolitical stability further bolster the U.S.’s growth outlook, justifying the valuation premium it holds.
The U.S. economy’s projected outperformance is underscored by the anticipation of a burgeoning AI investment cycle, which is expected to fuel a strong earnings cycle in the coming years. Earnings forecasts for 2024 include a +12% growth and +10% in 2025, in stark contrast to Europe’s more modest projections of a 9% EPS decline in 2024 followed by a 3% growth in 2025.
Historically, the S&P 500 has exhibited robust and stable earnings growth compared to European stocks, with an annual EPS growth rate of 7.3% over the past decade, nearly double that of Europe at +3.8%/yr. Additionally, the S&P 500 has maintained lower earnings volatility, with a standard deviation of earnings growth at 8% for the past decade, as opposed to Europe’s 18%.
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