At the moment, European equities are, as a whole, pretty cheap. And what’s more, those with higher leverage are even cheaper.
That’s according to Barclays, whose note today, “Learning to live with leverage”, details why it thinks European equity investors are still underestimating the impact of improved fixed income markets.
The bank thinks there’s a lot of value to be had in European equities, with the financial, utilities, telecoms and non-essential goods and services sectors having higher-than-average leverage.
European credit yields are still falling below those in the US, and credit default swaps are “back to pre-crisis levels across all sectors”.
Moreover, current levels of discount to US counterparts have, in the past, translated into “significant outperformance” of European equities, it says.
Crucially, the discount to the US doesn’t mean US equities are expensive - rather, it means European stocks are cheap.
Unlike their European peers, US-based investors haven’t been shy in making the most of opportunities to buy European stocks in bulk, while European investors are still “extremely cautious” about more leveraged parts of the market. The buying of European stocks by US investors is at its highest level since the early 1990s.
US purchasing into Europe has also been aligned with “value” outperformance. Barclays explains:
The influx of money from the US during 2013 coincided with a shift in favour of value stocks and continues a pattern that has been apparent since the launch of the euro, with US buying of European equities closely associated with the relative performance of value stocks within the European market.
The bank says it’s happy to reiterate the cheapness of European shares as a whole, but stresses that the “best prospects” are in sectors with deep discounts to US peers - and where improved fixed income markets, paired with economic recovery, will boost profits.
The best prospects
Given this stance, the bank’s upped its rating on the European utilities sector to small overweight from equal weight, because of this large discount to US counterparts, high leverage and “potential benefit” from the downward pressure low bond yields put on refinancing costs.
For the same reasons, it’s moved industrials down to equal weight, keeping its overweight rating on financials and underweight one on staples and healthcare.