The Short View

January 7, 2013 8:47 pm

Transatlantic valuation divide narrows

Washington and Brussels equally likely to spark next market disaster

Senior traders were back at their desks on Monday and it was no coincidence the new year rally came to an end. In the US, the wrangling about raising the debt ceiling, needed to avoid default at the end of next month or shortly after, has already begun, just a week after the ugly compromise to avoid falling off the fiscal cliff. In Europe, the disconcertingly orange-skinned Silvio Berlusconi is back in alliance with Italy’s Northern League, raising the odds of political turmoil – and amusing gaffes.

Last week’s post-cliff surge of optimism gave a bigger boost to US shares, naturally enough. But since equities started their post-election rebound in mid-November the eurozone has done better. At the same time, forecasts for eurozone earnings over the next 12 months rose, while for the US they were pared back a little.

Eurozone shares are now more highly valued than they have been since the week before Greece had to be rescued in 2010, on the basis of the forward price-to-earnings ratio. Given its reliance on analyst forecasts of profits and its historical record this is a doubtful measure. Still, Wall Street loves to use it and frequently argues that it shows shares are cheap.

At the moment it does no such thing. True, shares in the US and eurozone are cheaper than they were from 1995 through to 2008; but so they should be, given that period included the insanity of the dotcom bubble valuations. US shares remain more expensive than they were before 1991, or in the mid-cycle slowdown of 1994-95, while eurozone shares were often cheaper in the late 1980s and early 1990s.

The transatlantic divide has narrowed, as the US adopts austerity more seriously than most of Europe, while the euro looks safer than it has in years (if not actually safe). The discount of eurozone valuations to the US has plunged; it has been smaller only a few times in the past decade. Things look a little better, but Washington and Brussels are equally likely to be the scene of the next political disaster for markets.

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