Europe Bests US in Stock Opportunities

Following the global recession a couple years ago, I thought discussion about different sections of the global economy decoupling from one another would have ceased. Surprisingly, as Europe seemingly begins another economic downturn (several countries are already in a recession or depression), many investors and analysts remain of the opinion that Europe's problems will be largely contained. Will Europe's economic troubles be contained in the same manner as the US housing bubble (which was decidedly not)?

A post today on Pragmatic Capitalism, by Surly Trader titled UNITED STATES VERSUS EUROPE, highlights the divergence between the Eurostoxx 50 and S&P 500. The graph below compares the performance of these two stock indexes since the March 2009 lows. As you'll notice, the indexes initially moved significantly higher together, with Europe even outperforming to a small degree. Correlation remained pretty tight throughout the first portion of the sovereign debt crisis until May of this year. Since then, the S&P 500 is down nearly 15%, but the Eurostoxx 50 has lost more than 40%. Although a significant portion of the difference may stem from European banks (which currently face much larger funding issues), numerous other companies have been dragged down with the broader index.

Anyone reading or watching financial news over the past several weeks has surely heard a vast number of individuals argue that US stocks are extremely cheap based on forward looking earnings estimates. Ignoring for a moment that these estimates are almost always too optimistic, if one believes US stocks are cheap based on those metrics, than Europe is screaming "buy." As the article notes,

"The Eurozone is facing massive political headwinds, but at a dividend yield of 5.98% and P/E of 8.35, it looks relatively attractive versus the S&P 500′s 2.23% dividend yield and 12.71 P/E."

Based on these stock indexes, it certainly seems that Europe is pricing in a far worse economic outlook than the US. Holding the belief that if Europe experiences a significant economic downturn, the US will also be dragged into recession, European stocks, broadly, appear to offer a better risk/return profile.

Recent strength in US markets seems partially related to hope that the EU crisis will be kicked further down the road and that some version of QE3 will be announced next week. I've previously stated why the latter will be ineffective, apart from a short-term boost to stocks, and believe time is running out on the former. My personal view is to remain defensive, focusing on companies with strong balance sheets and large dividend yields. Two names within the Eurostoxx 50 that seem particularly enticing (and I currently own) are Sanofi (SNY) and Total (Tot). Both stocks trade at or below book value, sport P/E's below 7 and offer dividend yields above 5%. Maintaining a 3-5 year investment horizon, I believe these companies will offer significant relative value.