Investing.com -- The European equities are back to fair value levels following the unwinding of the so-called "Trump risk premium,” according to Barclays (LON:BARC) strategists.
While earnings per share estimates (EPS) have recovered due to the weaker euro, the majority of Europe's year-to-date (YTD) gains have been driven by a price-to-earnings (P/E) multiple expansion, with Financials and Cyclical sectors leading the way.
Since the beginning of the year, the MSCI Europe P/E has risen from 13.3 times to 14.5 times, slightly above the long-term average. This jump coincides with a reversal of the significant outflows experienced in November and December, aiding in the recovery of half of the underperformance of European stocks compared to the US throughout 2024.
“So the Trump risk premium that built up with the election has largely dissipated, leaving 'easy gains' behind us and EU equities near fair value, in our view,” strategists led by Emmanuel Cau said in a note.
Despite current valuations aligning with long-term averages, strategists see European stocks as “much cheaper” when employing long-term valuation metrics like the Cyclically Adjusted Price to Earnings (CAPE) ratio.
Compared to global and US markets, even after sector adjustments, European equities seem undervalued on all metrics, particularly when factoring in their stronger profitability in this economic cycle.
“We believe the relative valuation argument is still significantly flattered by how high the US is, which looks less justified after adjusting for Tech's high profitability,” strategists continued.
Cross-asset comparisons also suggest that European stocks are cheap relative to government bonds, with the Equity Risk Premium (ERP) near record highs against the US, although the gap narrows when compared to credit markets following a recent rally.
Looking forward, Barclays suggests that for European valuations to climb above average, two things need to happen: an ongoing improvement in economic activity data and lower interest rates.
These factors are interrelated, and the benefits of the European Central Bank's (ECB) recent rate cuts are expected to start reflecting the economic data.
The last period of sustained higher European P/E ratios above 15 times was between 2014 and 2018, during a phase of synchronized global growth.
According to Barclays, hopes for positive outcomes from the German elections and a peace deal in Ukraine, combined with potential rate reductions, could contribute to higher valuations throughout 2025.
However, the investment bank remains cautious, awaiting further confirmation of these positive trends before revising their valuation targets upwards.