Chart Of The Week   November 08 2022

Buy European Small-Caps Relative To Their US Counterparts

european small caps

BCA Research’s European Investment Strategy service concludes that European small-cap stocks have room to rally versus their US counterparts.

Despite near-term hurdles, European economic activity could remain strong relative to that of the US on an 18- to 24-month basis. Europe enjoys greater economic slack than the US and the worst of the energy crisis is in the rear-view mirror. Moreover, fiscal, financial, and monetary conditions are tailwinds for Europe relative to the US. Finally, an eventual re-opening of the Chinese economy may provide an important tailwind for Europe next year.

Better than anticipated European growth will not do much to boost the appeal of European large-cap names relative to their US counterparts in the near-term. European equities are dominated by multinationals that are more sensitive to global conditions than domestic economic ones. Since European earnings are more cyclical than US ones, the weakness in global growth will continue to weigh on their relative performance for a few more months

Instead, the most straightforward vehicle to bet on a positive-growth surprise in Europe compared to the US over the coming two years is European small-cap names relative to their US counterparts.  Small-cap stocks on both sides of the Atlantic have far more domestic bias than their large-cap siblings do. As a result, the relative performance of European small-cap names follows closely the evolution of both relative real GDP and durable goods consumption. Importantly, European small-caps are very cheap relative to US ones and have become massively oversold, which suggests that the current entry point is a low risk one.