Stoxx 600 Most Expensive Since ‘03 Shows Gain Is Over

By Jeff Kearns and Gareth Gore

May 18 (Bloomberg) -- European stocks are 55 percent more expensive than shares of U.S. companies just as the price of options to protect against losses in Europe climbs.

The Dow Jones Stoxx 600 Index’s biggest two-month advance in a decade pushed the gauge to 22.3 times its companies’ annual profits, compared with 14.4 times for the Standard & Poor’s 500 Index, according to data compiled by Bloomberg. While both measures have rallied more than 28 percent since March 9 on signs the global recession is easing, the gap in valuations is the widest since 2003, Bloomberg data show.

Options traders are paying 11 percent more to insure against Euro Stoxx 50 losses than on the S&P 500 amid forecasts that economies in countries using the euro will contract for at least another year while American growth will start to recover from the global recession later in 2009, according to data compiled by Bloomberg. European unemployment jumped to a three- year high in March and the International Monetary Fund said loan losses will rise at more than twice the rate of U.S. banks.

“It’s going to be a slower process coming out of this in Europe,” said John Carey, a Boston-based money manager at Pioneer Investment Management, which oversees about $200 billion. “If we do see recovery here in the fourth quarter, maybe then we’d be looking at the middle of 2010 for better conditions in Europe.”

The Stoxx 600 slipped 3.2 percent last week to 202.92, cutting its 2009 advance to 2.3 percent, while the S&P 500’s 5 percent retreat erased its yearly gain. The indexes fell more than 43 percent from their peaks in 2007 through last week.

Multiples Squeezed

Europe’s Stoxx 600 today slid 0.4 percent to 202.18 at 8:39 a.m. in London, while futures on the S&P 500 lost 0.1 percent.

Valuations for the S&P 500 sank 18 percent from an almost three-year high of 17.7 times earnings in May 2008 after banks reported almost $1 trillion in losses and writedowns since the start of 2007 and the economy contracted at the steepest rate in 26 years. In the past year, investors pushed the price-earnings ratio on the Stoxx 600 up 72 percent from 13.

“That might be an anomaly,” Carey said. “We could see a correction to bring the multiples closer together, especially in the view of better economic prospects here in the U.S.”

More than $12 trillion of government commitments will help restore U.S. economic growth by the third quarter of 2009, according to the average estimate of 63 economists surveyed by Bloomberg. U.S. GDP may decline 2.7 percent for all of 2009, compared with 3.25 percent in Europe, the estimates show.

Europe First

The average price-earnings ratio for Stoxx 600 companies exceeded the S&P 500’s level for the first time since 2004 on Feb. 26 as the U.K. government extended guarantees on financial assets and analysts raised profit estimates for European companies while cutting them in the U.S. The premium has since jumped from 16 percent at the end of April.

Georgina Taylor, who helps oversee the equivalent of $401 billion at Legal & General Investment Management in London, said European stimulus measures will prop up stocks in the region.

“We used to be of the opinion that the U.S. would come out of the recession first,” Taylor said. “But the U.K.’s policy response has been aggressive, and Europe is now catching up.”

Money is pouring into the U.K. on speculation the pound’s 28 percent drop against the dollar since November 2007 more than accounts for the country’s economic outlook. Currency flows from pension funds, insurers and other institutional investors in the 60 days to May 13 were more than 99 percent higher than any comparable period since 1997, according to Boston-based State Street Global Markets LLC.

Earnings Outlook

The U.K.’s FTSE 100 Index has climbed 24 percent from a six-year low on March 3, trimming its 2009 drop to 1.9 percent. The British gauge trades at 23.9 times the earnings of its companies, near the ratio of 24 on Jan. 9 that was the highest level since 2004, weekly data compiled by Bloomberg show.

Earnings for Stoxx 600 companies are forecast to climb 13 percent this year, compared with a 16 percent drop in the U.S., analyst estimates compiled by Bloomberg show. The projections rose by 13.3 percentage points for Europe since December and fell by 20.8 points for S&P 500 companies, the data show.

European estimates “may prove to be too optimistic,” said Joost van Leenders, an Amsterdam-based strategist at Fortis Investments, which oversees about $240 billion. “The Fed has been far quicker in cutting rates to boost the economy. We have a cautious stance on European earnings in the longer term.”

Federal Reserve, ECB

The Federal Reserve has slashed its target rate for overnight loans between banks from a level of 5.25 percent when credit markets started to seize up in August 2007 to a record low range of zero to 0.25 percent in December 2008. The European Central Bank reduced rates from 4 percent in August 2007 to 1 percent this month.

Twice as many S&P 500 companies beat analysts’ earnings projections as trailed them in the first quarter, according to data compiled by Bloomberg. Profits at more western European companies missed forecasts than exceeded, the data show.

Apple Inc. said April 22 that second-quarter earnings rose 15 percent. Per-share profits topped analysts’ average estimate by 23 percent after iPhone sales doubled from a year earlier. Shares of the Cupertino, California-based computer maker have gained 43 percent this year on the Nasdaq Stock Market.

JPMorgan Chase & Co., the second-largest U.S. bank by assets, reported profits on April 16 that topped estimates by 25 percent. The New York-based company has added 11 percent this year in New York Stock Exchange consolidated trading.

‘Downside Risk’

Options traders expect European companies won’t match the performance of their U.S. peers, according to Rebecca Cheong, senior equity derivatives strategist for Societe Generale SA in New York.

Implied volatility, the key gauge of price on contracts to buy and sell shares, is 11.3 points higher for bearish Euro Stoxx 50 options than bullish ones, the widest gap since October. The same gap for the S&P 500 is 5.1 points. Both calculations are based on the implied volatility difference between contracts 30 days from expiration that are 5 percent above and 5 percent below the current level of the indexes.

“There are more people concerned about the downside risk in Europe,” Cheong said. “There’s concern that in Europe some of the bad assets are still on the banks’ books and that they haven’t been as aggressive in writing them down.”

Bank losses in the euro area may rise almost fivefold to $750 billion through next year, while doubling in the U.S., the Washington-based IMF said in a report on April 21. Western banks that do business in eastern Europe face increased loan losses as economies from Hungary to Slovakia shrink.

Hungary to Bulgaria

Gross domestic product in Hungary and Romania declined an annual 6.4 percent in the first quarter, data from national statistics offices showed last week. The Czech economy shrank 3.4 percent, while Slovakia slumped 5.4 percent and Bulgaria contracted for the first time in 11 years.

Raiffeisen International Bank-Holding AG, the Vienna-based lender that operates in 17 former communist countries in eastern Europe, increased provisions for bad loans almost fivefold to 445 million euros ($601 million) last week as it posted a 78 percent drop in first-quarter profit.

“Emerging Europe is in a severe economic and financial crisis,” Nouriel Roubini, the New York University economics professor who predicted the financial crisis, said in an interview in New York. “If there are significant corporate defaults and credit markets aren’t functioning, that’s bad news for the recovery of earnings in Europe and for the sustainability of the equity market.”

‘That Headwind’

U.S. shares have an advantage because the American government took faster action to revive the economy, said Uri Landesman, who helps oversee $2.5 billion at ING Groep NV’s asset-management unit in New York.

“Europe is nine to 12 months behind the U.S. on a recovery basis,” Landesman said. “It still has that headwind.”

The bond market also shows investors are more pessimistic about Europe than the U.S. as unemployment in the euro area climbed to 8.9 percent. Treasuries lost 3 percent this year, according to Merrill Lynch & Co.’s U.S. Treasury Master Index. European bonds returned 1.1 percent, according to Merrill’s EMU Direct Government Index. Debt in Germany, Europe’s biggest economy, declined 0.5 percent.

For the first time since Bloomberg began surveying users in 2007 on their outlook for stocks, investors expect the S&P 500 to rise in the next six months. A confidence gauge for U.S. equities climbed to 51.6 this month, with readings above 50 showing investors see gains. No European country’s reading was above 50 in the survey of 1,092 users from May 4 to May 8.

“The economic hurricane has definitely left the shores of the U.S.,” said Paul Britton, chief executive officer of New York-based Capstone Holdings Group, a trading firm specializing in options. “It may miss the bulk of Europe and just affect a small amount of territory, but if the path changes and goes head on into Europe, the devastation will be pretty significant.”

To contact the reporters on this story: Jeff Kearns in New York at jkearns3@bloomberg.net; Gareth Gore in Madrid ggore1@bloomberg.net.