By Nicholas A. Vardy, CFA
If you look at the headlines, the contrast between the U.S. and European economies could hardly be greater.
Last week's Bloomberg Business Week has a roaring American Bald Eagle riding a Harley Davidson motorcycle. The article celebrates the American economy's flexibility and the savvy of U.S, policymakers at the height of the financial crisis.
In contrast, Tuesday's Financial Times in London features an awkward picture of Greece's new radical leftist prime minister clad in a leather jacket alongside his buttoned up U.K. counterpart in front of Number 10 Downing Street. The British Chancellor was urging his Greek counterpart — a self-avowed Marxist — to "act responsibly" to avoid "the greatest risk to the global economy."
Neither of these images wants to make you open your checkbook and invest in Europe.
Yet, the performance of the U.S. and European stock markets in 2015 tells a different story.
So far this year, the Europe ETF MSCI Vanguard /zigman2/quotes/200270338/composite VGK -0.78% is up by 2.58%. That compares with a 0.72% loss for the SPDR S&P 500 ETF /zigman2/quotes/209901640/composite SPY +0.66% .
The major European stock markets are performing even better. The iShares MSCI Germany ETF /zigman2/quotes/204789209/composite EWG -1.17% is up 4.85% and the i Shares MSCI France ETF /zigman2/quotes/202869500/composite EWQ -0.96% has gained 3.29%.
If it weren't for the collapsing euro, you'd already looking at close to double-digit gains in each of these markets less than five weeks into the New Year.
Why europeans stock markets will outperform the U.S. in 2015
I believe Europe's U.S. market-beating returns are just the beginning of a longer period of outperformance.
This prediction may leave you scratching your head
After all, the Old Continent is on the verge of entering recession. Sixteen eurozone economies reported falling prices in December alone. And many major European economies are burdened with serious structural challenges.
And, of course, as last week's headlines confirm, you never know the wrench Greece is ready to throw into the works.
But look below the surface, the outlook for European stocks isn't as negative as most investors think. Here's why...
First, there's the issue of valuation. European stocks are simply cheaper than those in the United States. According to Morgan Stanley, European stocks have not been this cheap relative to the U.S. since 1979 when Jimmy Carter occupied the White House.
Based on the cyclically adjusted price/earnings (P/E) ratios — Nobel Prize-winning economist Robert Shiller's favorite measure — European stocks currently trade at nearly a 40% discount to U.S. equities. That compares with an average historical discount of 10%.
Second, a 40% discount to U.S. stocks could be justified if European companies had lousy earnings. But that's not the case. Although their economies are stagnant, European corporate earnings are expected to grow by 10% in 2015. That compares to 6% to 8% earnings growth in the United States.