US and Europe CAPE ratios keep diverging

• In the past cycle, one striking observation has been the sharp divergence between the performance of US and European equities.
• While the accommodative stance of the Fed keeps pushing US equities to new all-time highs, political uncertainty combined with the slow growth have been weighing on European stocks, which are still trading 12% below their 2008 (and way off their 2000 high).
• Even though many practitioners have criticized the CAPE (cyclically- adjusted price to earnings) ratio as a predictor of future stock returns, CAPE has explained 90% of the variation in 10Y returns when looking at monthly data from 1995 to 2020.
• The chart below shows the sharp divergence in the CAPE ratios between US and Europe since the Great Financial Crisis; while the US CAPE was at 38.3 in the end of April, Europe CAPE was at 23.45 (below the 25 high in 2007).
• Even though European stocks are considered 'cheap' according to a set of value metrics such as CAPE, they have been much less sensitive to the rise in global liquidity and therefore have experienced a much slower recovery relative to US equities.

Source: Bloomberg/Barclays/MNI