European share prices remain undervalued, even after the sharp rally of the past few weeks, according to a leading London-based analyst.
Renewed commitments to quantitative easing from central bankers on both sides of the Atlantic have lifted European equity prices by 18 percent from their July lows, yet prospective price-to-earnings ratios have risen to just 10.6, said HSBC strategist Peter Sullivan in a note released early Monday. That’s significantly below the long-term average of 15 times earnings.
But Sullivan added a note of caution, pointing out that the macroeconomic outlook remained cloudy, with concerns over the U.S. “fiscal cliff” and the leadership succession in China.
Historically, value stocks have outperformed during times of uncertainty, he added, singling out banks, diversified financials, telecommunications, and energy shares as good bets.
“Our reasoning is that, almost by definition, expectations are low for value stocks and this makes them more resilient to the shocks that are inevitably in store for us,” he said.
Sullivan also believes that downgrades to earnings of European shares have been overdone. The consensus forecast for earnings per share growth has slipped through the year, with most analysts now predicting earnings to fall by 0.2 percent in 2012. Sullivan believes that earnings will be flat at worst, and could rise by as much as 0.5 percent.
But other analysts were less optimistic on Monday. Philipp Baertschi, of London-based Sarasin, believes that earnings estimates for next year are 10 percent too high and forecasts “negative surprises” to earnings growth. Despite the historically low level of price-earnings ratios, Baertschi sees little immediate upside potential for European share prices.
While Baertschi believes equities will outperform fixed-income assets over a five-year time frame, the hunger for the safety of government bonds will limit the upside of share prices. Equities are unlikely to extend recent gains until investors begin to consider a major reallocation of assets, which will only take place “when investors start to lose money on bonds,” he wrote in a research note.
—By CNBC.com’s Laurie Laird
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No disclosure information was available for Peter Sullivan or Philipp Baertschi.