"The discount on European equities has never been greater". It's an example of how what's cheap can stay cheap for a long time: the famous "value trap" concept. And it's a problem that goes beyond the simple match of stock markets.

European equities are currently trading at 13.2 times next year's earnings, which is close to their long-term average. This compares with 21.6 PE forward for US equities (versus 18.2 for their 10-year average). Over the past decade, the gap has widened steadily. Buoyed by a handful of mega-caps with insolent profitability, Wall Street is racing ahead and crushing the rest of the world. The United States now accounts for 74% of the MSCI World index, but only 25% of global GDP.

Vicious circle

At first glance, the valuation discount is not a problem. If we worry all day long about high valuations in the US, we can only rejoice in the fact that the European market is cheap. 

But what are we seeing in practice? More than long term investors, it's private equity that's attracted to European markets and coming to do business. Indeed, valuations are much more attractive than in unlisted markets. We saw this again recently with the takeover of Neoen by the Canadian fund Brookfield. As a result, many quality companies are delisted and end up in the hands of private equity funds (ironically, the largest private equity funds are listed on the stock market). This mechanism means that the European stock market, and in particular the small and mid-cap segment, is gradually losing quality, which in turn feeds investor disinterest.

Secondly, from the point of view of European companies, the discount also acts as a brake. Unlisted companies are not attracted by a market that does not value them well, which often pushes them to list in the United States or to remain in the unlisted sector, which has become much more structured in recent years, enabling us to support companies up to much larger capitalizations.

For companies that are already listed, there is another disadvantage. When they seek to grow externally (i.e., by acquiring another company), and buy out an American competitor who sometimes opens up this market, the valuation gap means that the transaction price is high. In many cases, the market reacts badly to such rumors, and the stock takes a beating, nipping the acquisition project in the bud. This is what happened last September, when Bloomberg reported that Sodexo was interested in acquiring its American competitor Aramark, which is equivalent in size in terms of sales. At the same time, Elis was sanctioned for its interest in the American company Vestis.

Structural discount

The valuation discount on European equities is primarily the result of Europe's political and economic situation. An aging continent with low growth potential. An economically and financially less integrated zone. A politically fragmented zone, whose main leaders are weakened.

All this is reflected in the figures. Since 2019, European nominal GDP growth has been only 40% of that of the United States. And the growth in earnings per share expected by European companies in 2025 will be around half that of their American rivals (+8% vs. +15%), despite good international exposure.

This brings us back to the Draghi report's observation that Europe is a continent where everything seems to stand still. One fact sums it up: the three European companies filing the most patents are the same as at the turn of the century (3 carmakers). This is more incremental innovation than disruptive innovation, which is what creates value. As a result, debates are limited to how to regulate other people's innovations.

In the face of this situation, one subject keeps coming up again and again: the sea serpent of capital market union. But this beautiful idea always comes up against reality. Last September, Unicredit announced its intention to consolidate the European banking sector. Its main target: the German bank Commerzbank. But the German political class and trade unions rose up as one. There's no question of a German flagship coming under Italian control. Even if, officially, the fear for jobs was more important. Where do we stand today? Earlier this week, the Financial Times reported that Commerzbank was considering job cuts in order to present a more attractive image to investors...and thus avoid a takeover by Unicredit.