Are European equities too expensive or normally valued?
What “macroeconomic” viewpoint can we have on this question?
– The PER normally depends on the differential between long-term interest rates and nominal potential growth and the level of risk aversion (determining the level of the equity risk premium); at the current level of these variables, the Euro Stoxx is slightly overvalued (8%);
– If we look at the longer term, the PER depends on the differential between the “normalised” long-term interest rate and nominal potential growth, corrected for the risk premium. This raises the question of how high euro-zone long-term interest rates will rise. If we assume a normalisation identical to that in the past, we arrive at a more marked overvaluation of the Euro Stoxx (16%);
– Equity valuation can obviously be disrupted by exceptional factors:
• The distortion of income distribution, which can cause a divergence between profit growth and nominal GDP growth; this factor has not had any impact since 2012;
• The abundance of liquidity (thanks to quantitative easing), which can generate a large flow of purchases of equities, and therefore a PER that is persistently higher than its fundamental value. This factor is obviously at play and justifies the slight overvaluation of European equities.
