BCA lists 5 reasons you should load up on European stocks

Investing.com -- The investment case for European equities is strengthening as structural headwinds fade and valuations remain historically cheap, according to BCA Research.

Since 2007, European stocks have underperformed U.S. equities by 220%, but recent trends, including a €1,000 billion German stimulus package and fading faith in U.S. exceptionalism, have narrowed the gap.

Year-to-date, European equities have outperformed by 16% in common-currency terms.

In a note published Thursday, BCA outlined five reasons why investors should increase exposure.

1) ‘Historically cheap valuations:’ The 12-month forward price-to-earnings (P/E) for the Euro Area MSCI index is 14.2 versus 22.8 for the U.S., a 38% discount.

“This valuation discount cannot be solely attributed to the tech sector or the AI superstars. Every GICS1 sector trades at a historically large discount,” BCA’s chief Europe strategist Jeremie Peloso said.

He notes that cheap valuations “offer more protection against adverse shocks than U.S. stocks do, at a time of heightened concentration risk,” with Nvidia and Microsoft accounting for almost half of S&P 500 returns this year.

2) ‘More integration, less division:’ Positive sentiment toward the euro and EU is at an all-time high.

The bloc’s handling of the pandemic and energy crises, along with initiatives like Next Generation EU, RePowerEU, and ReArmEU, have strengthened integration.

Efforts toward capital market union and reducing market fragmentation are seen as tailwinds for equities.

“Convergence in policy uncertainty will narrow Europe’s excess risk premium over the U.S.,” Peloso wrote.

3) ‘Fiscal austerity is gone:’ A decade of fiscal tightening has given way to more accommodative policy. Germany has lifted its debt brake and launched a €1,000 billion spending plan focused on defense and infrastructure.

Meanwhile, Peloso says the U.S. is “forced to abandon its reckless profligacy,” with fiscal policy turning from a tailwind to a headwind.

“This change in relative fiscal stance is also positive for the performance of European stocks relative to US ones since fiscal differentials affect real economic growth and returns on invested capital,” he added.

4) ‘Private-sector deleveraging is done:’ Outside France, private-sector debt has fallen to its lowest in 17 years.

European banks have rebuilt balance sheets, profitability has improved, and nonperforming loans are no longer a major concern.

As banks account for 70% of corporate borrowing in Europe, a healthier sector is expected to support growth and capital investment.

5) ‘The U.S. dollar has entered a multi-year bear market:’ Lastly, the dollar is down 11% against the euro this year, and BCA sees the trend continuing toward 1.40.

While a stronger euro can hurt exporters, “the currency return enhances the performance of European stocks held by investors in the U.S.”

Firmer domestic demand reduces reliance on exports, allowing equities to rise alongside the currency.

Overall, BCA says “the current episode of European outperformance is not over” and maintains an overweight stance on European equities versus U.S. ones on a cyclical horizon, especially in common-currency terms.

On a risk-adjusted basis, it favors its DIVE basket — sectors highly correlated with the “Magnificent 7” but with more attractive valuations and broader diversification — and European small caps, which have outperformed U.S. small caps by 17% this year.