(August 21, 2012) — The United States is outpacing Europe in terms of its financial strength, so deciding where to allocate to equities should be simple – shouldn’t it?
According to Lars Kreckel, Legal & General’s global equity strategist, the US economy is growing, while Europe is facing a seemingly endless recession. “The US has a proactive central bank willing to support growth, while Europe has a central bank focused on inflation rather than growth. The US has a political system capable of making decisions in a crisis, while Europe is governed by an unwieldy system requiring agreement of 17 heads of state from different political parties at different stages of election cycles,” Kreckel stated in a newly released paper.
However, while being overweight US equities may seem like a no-brainer, LGIM recommends being underweight the asset class in the US. “Before getting into the details of our argument we must mention an important caveat…Rather than focusing on absolute growth, we are more interested in comparing regions – assessing the prospects for US economic growth, equities and earnings, compared to the European equivalents.”
The paper continues: “European earnings forecasts have been under pressure for the past 18 months, but until recently US consensus forecasts had remained stable. With the Q2 reporting season this trend has changed. While European earnings are still under pressure, analysts have begun cutting some of their US estimates as well. The S&P 500 had its worst pre-announcement season of this cycle with over three times as many companies pre-announcing negatively than positively. In relative terms the earnings revision ratio now looks better (or less bad) in Europe than in the US for only the third time since 2009. Part of the pressure on US earnings comes from the stronger US dollar, which has appreciated 12% over the past year against a broad basket of currencies.”
The most recent Merrill Lynch fund manager survey recorded that a net 13% of respondents were overweight US equities, roughly one standard deviation above the normal reading, Lars noted. Meanwhile, European equities recorded one of the highest consensus underweight positions in the past decade. “From a contrarian perspective this suggests the ‘buy US’ trade is overextended,” Kreckel concluded.