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European Equities Poised to Outstrip U.S., Say Strategists

NEW YORK (TheStreet) -- Strategists increasingly prefer European markets to those in the U.S., claiming there is stronger upside for the region amid better economic data, attractive valuations, and growing speculation of more stimulus.

By contrast, U.S. markets have been fluctuating between gains and losses on a daily basis as higher valuations and tepid earnings growth are blamed for a lack of direction.

ClearPath Capital Partners chief investment officer, Brendan Connaughton, said he sees similar conditions in Europe to those that existed in the U.S. before its big rally: low interest rates and signs of a pick-up in economic growth. This means potential European rallies have further to run Connaughton said, predicting several developed indices will outperform the US on a three-year basis.

"The U.S. is a petri dish for what could happen in Europe," he said. "We don't need more stimulus in Europe for stocks to do well, but we think we'll get it."

The MSCI Europe index has posted total returns of 106% since the market nadir of 2009 while the S&P 500 has notched a return of more than 175%. European equity gains have been restrained by the region's debt crisis in 2010, fears of a Greek exit from the euro in 2012 and rising tensions between Ukraine and Russia this year.

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Federated Investors is among those who see a brighter outlook. The fund manager raised its exposure to Europe during the first quarter, from 40% to 56.5% for a World ex-U.S. fund. Head of international equities Audrey Kaplan said the firm sees more signs of a sustained economic recovery, while sentiment continues to improve.

"Europe also has more (stimulus) instruments available relative to the U.S. such as lowering rates, a new communications strategy and talking down the currency," she said.

Kaplan also pointed to attractive valuations. As Europe's largest economy, Germany is trading on 12.8 times earnings vs. 15.5 times for major U.S. markets. German equities also carry a book value of 1.8 times vs. 2.6 times for the U.S.

The fund manager likes several emerging European markets on a longer-term basis, acknowledging the sentiment hurdle they face this year. Kaplan pointed to the discount on several equity markets due to Ukraine tensions, a situation many believe is unlikely to impact the longer-term value of European equities. Given this, several Austrian and Czech stocks are trading below their break-up value while Hungry and Poland also present opportunity, Kaplan said. Economic data is also improving in these countries as exports return to post-Lehman levels.

Similarly, Connaughton said he prefers European markets that are still slightly out of favor. He favors Germany, France and Spain as good picks on a three-year basis and cautions investors not to chase the end of rallies in markets such as Italy. "There's a better jobs situation (in the former three countries) which will drive demand, along with government austerity. It's not yet reflected in valuations or stock prices," the fund manager said.

Societe Generale's global head of research, Patrick Legland, said he remained "very positive" on European peripheral indices. "Our preferred indices are Italy and Spain, which continue to trade slightly above price to book value (1.5x) and below historical averages (3x)," he said. "Should the ECB decide to go for quantitative easing type measures, it would be very positive for these countries."

But some remain wary. ING U.S. Investment Management market strategist Karyn Cavanaugh said low bond yields in Spain and Italy reflected growing expectation that the European Central Bank would announce further stimulus and "float all boats."

"But we don't know what the ECB will do," she said, suggesting investors stick to fundamentals instead of stimulus speculation as a basis for investing.

Cavanaugh said challenges remained even as Europe's macroeconomic outlook appeared to have turned the corner. "In the U.S. the fundamentals are better and there's more potential for growth," she said. "First quarter GDP was horrendous but manufacturing numbers are better and there's been a jump in consumer spending."

-- By Jane Searle in New York

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