European equities have had a strong 12 months. In dollar terms the region's equity markets have increased in value by 1.9% over the last month, 5.2% over the last three months and 24.9% over the last 12 months. But even after these increases European equities are still below average in valuation terms - based on 2017 estimates for the full year European equities are valued at 16.5 times earnings compared to 17.7 times earnings for the MSCI World which includes all developed world countries. Looking into 2018, according to IBES numbers, European equities are 15.1 times earnings compared to 16 times for the rest of the developed world. These relatively low valuations, plus the evident momentum in local share prices has led to huge inflows into European ETFs over the last year.
But despite these tailwinds European corporates are facing a deeper structural problem - they increasingly don't matter when compared to US and EM equities, with earnings growth notably lagging. This is the slightly alarming conclusion contained in a weekly note from Andrew Lapthorne, chief quantitative strategist at French bank SocGen. In his weekly report to investors Lapthorne observes that in the ten years since the start of the financial crisis the US equity market "has gone from strength to strength and now represents over 50% of the world's market capitalisation, a level not seen since 2001". According to the SG strategist most of that market share gain has been at the expense of Europe, where market cap share has dropped from 30% to 20% over the same period.
According to Lapthorne some of this could be "due to the over valuation of US equities versus the rest of the world, and to a certain degree that may be true. However, the bigger reason is perhaps more worrying for Europe; European quoted sector profits are now only 50% of US quoted sector profits, having been the roughly same just prior to the financial crisis, and are now back at levels last seen in 1984 when there were far fewer listed European equities. Looking at the split between the Eurozone and the UK, the former has seen its market cap share shrink from 15% to 11% since 2007, while the UK has dropped from 10% to 6%. So, both regions have performed poorly".
Crucially emerging markets are also taking a bigger share of profits, with the MSCI EM index now representing 16% of global earnings compared 10% in 2007 - "a number that excludes a significant number of China A shares that also continue to gain global market share" according to Lapthorne. "With the US already dominating and Emerging Markets inevitably getting bigger, the question for policy makers in Europe is how to reverse this now significant down trend?"