By Randall W. Forsyth
Nobody goes there anymore, it's too crowded. So said that late, great philosopher, Yogi Berra.
Case in point: Europe. And it isn't just Barcelona, where locals protested the hordes of tourists last summer by spraying them with water guns.
Some contrarian-minded investors have rushed into European stock markets in recent months, notwithstanding the persistently sluggish economies on the continent, resulting in strong gains in those bourses. Most likely, they were drawn to Europe by the equities' extreme undervaluation after longtime laggard returns. On that score, the MSCI EMU index of large- and mid-cap European stocks trades for about 14 times expected earnings for the next 12 months, less than two-thirds the 22 times forward price/earnings multiple on the S&P 500 index.
Many of these investment "tourists" now find they have too much company and are taking their winnings and going home. But more experienced global investors can still find compelling values among individual European stocks rather than the broad exchange-traded funds that first attracted the tourists.
For all the talk of American exceptionalism, European stocks have outpaced U.S. stock indexes of late, and that's despite the dominance of the big technology names among the latter. Among major ETFs of the sort that would populate Barron's readers' portfolios, the Vanguard FTSE Europe ETF (ticker: VGK) has returned 9.96% in 2025 through Wednesday, according to Morningstar data, better than twice the 4.61% year-to-date return of the Vanguard S&P 500 ETF $(VOO)$. The iShares MSCI Germany ETF $(EWG)$ has returned an even greater 13.32% so far this year.
Bank of America's latest survey of fund managers, released this past week, found that 12% of respondents were overweight European stocks, the highest percentage of accounts since last June. While relatively low, that still represented a big swing from 36% having been underweight Europe just two months earlier, as bargain hunters were attracted to the vastly cheaper valuations of European equities compared with the Magnificent Seven stocks that dominate the U.S. market.
That investors would venture to Europe might seem counterintuitive, especially since Germany, the continent's largest economy, is facing its third year of recession and has a crucial election ahead this Sunday. Still, the DAX hit a record this past Tuesday, and was up 28.5% from a year ago at Thursday's close.
Neither have European stocks suffered from the America-first policies of President Donald Trump. Indeed, in a perhaps perverse way, Trump is pushing Europe in the right direction, said David Herro, lead manager of the $4.2 billion Oakmark International fund (OAKIX). Herro is a veteran value investor who has long favored European stocks.
For one thing, Trump has insisted that Europe will have to pay more for its own defense, which has made defense-equipment stocks the leaders of the rally, said Herro. Plus, the prospects for an end to the Russia-Ukraine conflict could lower energy costs sharply, especially the price of natural gas (although that seems a meager payoff for Trump's Orwellian assertion that Ukraine started the war, which The Wall Street Journal's editorial page said " mimicked Russian propaganda").
There are signs that American investors may be all in on Europe. Part of the influx was an "unwind of the U.S. exceptionalism theme," according to a research report by the J.P. Morgan global markets strategy team led by Nikolaos Panigirtzoglou. That has led to a markedly overbought technical condition in the Eurostoxx 50 index of big, blue-chip sector leaders, which can persist, especially if retail investors continue to pile in, the team wrote.
So far this year, investment flows tracked by the bank have been heading into Europe. European equity flow has returned to its high of 2023 from close to a maximum short position in late 2024, and is near the level of early February 2022, before Russia's invasion of Ukraine.
Some European stocks may be a bit too rich now. Year-to-date gains "look extended" among potential beneficiaries of a Russia-Ukraine cease-fire, the JPM note said, such as companies that would benefit from reconstruction and those that would be helped by lower European Union gas prices. That's in line with the observation from a bank trading desk that the momentum in European stocks may be waning.
But Herro still sees compelling values, noting that "companies aren't countries." In other words, it matters more where a firm does business than where it is domiciled.
Mercedes-Benz Group, whose shares slumped 2.5% Thursday (after having risen nearly 20% since mid-November) is one example. While the auto maker warned of lower profit margins owing to sluggish global demand, especially in China, where it faces tough competition, Herro cited Mercedes' financial strength -- specifically 31 billion euros ($32.4 billion) of cash on its balance sheet, relative to a stock-market capitalization of EUR57 billion.
Mercedes pays a healthy dividend yield of 6%. Plus, it will be using its cash to buy back 10% of the shares, Herro said.
Financial stocks also have been among the leaders in the European rally, and Herro favors BNP Paribas, which he calls one of highest-quality institution that "ranks right up there" with JPMorgan Chase. Paribas' shares trade at about seven times earnings and at 70% of book value, while the big French bank has been posting a strong return on equity of 13% to 14%. Paribas pays a dividend yield of 6.8%.
By comparison, JPMorgan Chase trades for 2.3 times book and 13.3 times earnings, and yields less than one-third as much, or 1.9%, Herro noted.
Value has always been the attraction of big European stocks, although it has been diminished a bit by the recent rally. Yet while some of the short-term trading gains may be behind European shares, and uncertainties regarding U.S. tariffs loom, this trade isn't too crowded for select names like those Herro favors.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
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February 21, 2025 15:16 ET (20:16 GMT)
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