Buy crisis gaps at new high: Europe is cleansed
Time is right: Europe has just lived through 3 Black-swan like events
Crisis Gaps: surprisingly at the highest level in crisis
We were taken aback when we combined the gaps. The gap below is higher today
than at any time since the 08/09 crisis. The gaps we focus on include: 1) Real yield gap
for Equities vs Bunds where equities still offer 80% of their peak excess yield. 2) UBS
Cyclical/Defensive index is today below its 09 and 12 crisis troughs. Cyclicals are valued
for a recession (pg 19); and 3) Europe vs the US: the profit 'and' valuation gaps are at
90% of their peak at any time during the crisis.
How can they be higher than in the Mar 09 or Jul 12 meltdowns?
The US and European profit gap in early 2010 was only one-fifth what it is today.
Europe's ROE gap to the US is still at a decade high (fig 1). We may be putting the
sovereign debt crisis, austerity straight jacket, stress tests and a lock-down in credit
markets behind us, but they drove a DIVIDE between Europe and the US that is
'combined' at its highest level today. The cyclically adjusted PE (CAPE) comparison
suggests Europe is in recession. Plus, this isn't just about Technology and/or sector
differences. Our Sector Adjusted PB comparison to the US (pg 3) also shows levels
normally associated with a Europe that is in recession.
But why will gaps narrow? Europe is cleansed after 3 Black Swan like events
Europe has been through: 1) Sept 08 Lehman's shock: Financial profits fell 72% and
the profit hit was a '6.4 standard deviation' event (once in every 22,000 months); 2)
Oct 09 Greece shocked all and during 2012 Italian bond spreads experienced a 2.8
standard deviation move; 3) Jun 14 brought the commodity meltdown: the cut to
Energy earnings was a 3.5 standard deviation event and helped to wipe out Europe's
EPS growth for this year. We believe that Europe has been largely cleansed of last
cycle's material excesses and is now free to focus on growth.
Trades: Buy Europe, ROE 'catch up to US' & Cyclical dividends
1) DJStoxx 600 vs S&P500. CAPE PE & Sector Adjusted Price/Book gaps are at recession
levels; 2) ROE catch-up to US offer names with a Value Tilt; 3) Safe Cyclical Yield:
relative yield to defensives at a decade high, list offers yield of 4.7%.