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Market Memo: Why we favor Europe over the U.S.

As of 06-19-2013

To say we think global equity risk remains in moderate-risk territory and bond risk is in high-risk territory isn’t going to surprise many people. It’s sort of a, “No duh.” But what if I told you that we also think, on a relative basis, U.S. stocks are a higher risk than European equities? Given the eurozone’s ongoing recession and a U.S. economic recovery that however anemic is entering its fifth year, how can that be?

Simple: When it comes to equity investing, you buy the future, not the present. And our research suggests continental European equities offer better opportunities at current price levels than do U.S. stocks. The S&P 500 and the Dow both set new highs in the past month, capping a remarkable run from the lows of March 2009. On the other hand, European stocks as measured by the Euro Stoxx 50 remain well off their pre-Lehman highs and have had a much rockier, albeit still positive, year-to-date performance.

Moreover, the risk on European stocks has been reduced not only by the European Central Bank’s “whatever-it-takes’’ mantra but also by a generous global liquidity backdrop. While much of the focus recently has been on the Bank of Japan’s massive quantitative easing, there have been 329 stimulus steps taken around the world over the past 16 months, not limited to just QE and interest-rate cuts but also including ramped-up infrastructure spending, tax incentives and other pro-growth initiatives.

Moving out of danger zone
All of these efforts should cushion Europe’s stabilizing, increasingly export-oriented economy as the Continent moves from danger zone to recovery as some of the most recent data suggests is occurring. In May, for example, every country in the eurozone reported an increase in its PMI for the first time since July 2009, with the largest monthly gains coming in Spain, France, Italy and Germany. Also, three-quarters of the eurozone PMIs were above their year-ago levels, with Greece’s and Spain’s readings near two-year highs, France at its best level in over a year and Germany, the Netherlands and Austria close to the expansionary 50 mark.

Finally, Europe is moving to separate sovereign risk from banking risk through reforms that should begin in earnest this summer and ultimately result in a fully functioning banking union. By July, the ECB is supposed to start assuming supervisory powers for the largest banks in the eurozone under the Single Supervisory Mechanism agreed to in March, and this eventually will be extended to all eurozone banks. The reforms are critical to Europe arriving in a better place, though it would be surprising if all goes smoothly—this is Europe after all. September’s elections in Germany could help. If it produces a “Grand Coalition’’ between the Chancellor Angela Merkel’s Christian Democratic Union and the Social Democratic Party, it could help ease the path for these much-needed reforms.

None of this is to suggest we don’t like U.S. stocks or that we like every European country. Relative to the alternatives (cash and bonds), U.S. equities still look attractive on a growth and forward P/E basis. We just think much of Europe (ex-U.K. and the peripheral economies) looks better on the same basis.

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Dow Jones Industrial Average ("DJIA"): An unmanaged index which represents share prices of selected blue chip industrial corporations as well as public utility and transportation companies. The DJIA indicates daily changes in the average price of stocks in any of its categories. It also reports total sales for each group of industries. Because it represents the top corporations of America, the DJIA's index movements are leading economic indicators for the stock market as a whole. Indexes are unmanaged and investments cannot be made in an index.
Euro Stoxx 50 is an index of 50 blue-chip European stocks developed by Stoxx Ltd. and meant to represent sector leaders in the eurozone. Indexes are unmanaged and investments cannot be made in an index.
International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.
Price-earnings multiples (P/E) reflect the ratio of stock prices to per-share common earnings. The lower the number, the lower the price of stocks relative to earnings.
S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.
The Eurozone Purchasing Manufacturers Index (PMI) of manufacturing is a monthly gauge of the level of manufacturing activity in the euro zone.
Federated Global Investment Management Corp.
Copyright © 2014 Federated Investors, Inc.

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