European equity markets are a dollar short this year. A US Dollar (USD) short to be specific. The STOXX 600 index (the European equivalent of the S&P 500) is up a few percent this year in local currency terms but down slightly when translated to USD. As the Fed has continued its path of interest rate normalization and short-term rates have lifted off so has the USD on which that interest rate is paid. Relative to a basket our trading partners, the US Dollar is up 3.8% this year most of which has come in the past few months as expectations for Fed action tilted more aggressively. Gold too is victim to the rise in rates falling almost 9% this year despite the pick-up in volatility and mounting fear of “peak growth” that flashes in news headlines.
So continues the ongoing outperformance of the US equity relative to the rest of the world. Over the last 5 years along, the S&P 500 has outperformed the MSCI All Country World ex-US (ACWI ex-US) index by 7.4% per year and the actual streak is even longer. At some point, the valuation gap will matter. On a trailing basis, the P/E multiple of the S&P 500 is 21.3x versus the ACWI ex-US of 14.9x. Valuation, as we know, is an incredibly poor timing tool. We are starting what looks to be another strong earnings season with year-over-year growth likely to be in the 20% camp. The valuation gap between the US and the rest of the world shrinks a healthy amount when you look at price to next twelve months’ earnings. With the added benefit of a strengthening currency, it is too quick to short-change the near-term outlook for US equity.