The Valuation Gap: A Major Catalyst for U.S. Capital Flow to European Stocks

The U.S. stock market has been advancing at a rapid pace, with the S&P 500 up 23% since October and now trading at an average P/E above 21x. In contrast, European markets, while performing well, offer a significant discount relative to the U.S. The STOXX 600 trades at approximately 14x EPS, a steep ~50% discount that is attracting serious interest from U.S. investors.

Hedge funds, often the first investors to spot opportunity, are now more exposed to European stocks than ever before, while long-only mutual funds have allocated the most capital to European stocks since June 2020, as reported by Bloomberg. The historically low EUR/USD exchange rate is offering U.S. funds another reason to commit now, and as interest rates come down, there is significant opportunity for investors to capitalize on the better relative valuation opportunities in Europe and broaden exposure to more cyclical parts of the market.

The valuation disparity in Europe is not only catching the eyes of public equity investors; U.S. private equity firms are taking notice as well. The first quarter of 2024 saw a jump in U.S. private equity deals with European businesses, as private equity firms embraced the idea of paying a discount for an equally valuable business in Europe. The valuation disparity is so significant that private equity firms have been willing to pay large premiums for discounted European companies to avoid the risk of overpaying in the U.S.

As the S&P 500 continues to climb to record highs, U.S. institutional investors are looking for value in European equities. The aggregate market capitalization of U.S. stocks has grown to 2.6 times that of European stocks, the highest gap since the early 1980s (Source: Goldman Sachs). All things considered, we are at a pivotal point in history as the U.S. and European stock markets have fallen completely out of sync. Shifting investor sentiment about market risks has unlocked a new world of opportunity, pointing to a more favorable outlook for European equity markets relative to the U.S. This shift is more than likely to push European stock prices higher and narrow the valuation gap between Europe and the U.S.

With significant buying interest coming from the U.S., European companies are well-positioned to capitalize on this unique and timely opportunity to gain new investors who view their companies with a fresh perspective outside their local market. However, without a local advocate with deep expertise of the North American markets, identifying the right investors and making introductions can be challenging. Banks have scaled back their support to the bare minimum, complicating the process of attracting U.S. capital despite the compelling valuation differential.