Stocks have come under intense pressure since the summer. The markets seem to be focused on macro-orientated news that is mostly negative: the Eurozone is imploding, the US is locked in political deadlock, and China will have a hard landing. These headlines have caused supreme fear and pessimism which has caused stocks to sell-off. But is this fair? Some high quality companies have come under intense downward pressure and prices are close to 2009 lows.

This has helped to supress valuations, and some stocks are trading at historically low prices according to the price-to-earnings (PE) ratio. So does the macro crisis offer an opportunity to equity investors?

The charts below look at the current and estimated price-to-earnings ratio – a measure of value based on a stock’s price relative to its current and estimated future earnings. The indices we will focus on are the Eurostoxx 50 and the SPX 500.
Eurostoxx 50: This index has been hit hard by the Eurozone debt crisis and has been sold off sharply; it is currently down nearly 25% since the start of the year. This index has been dragged lower by European banking stocks, which have been hit hard by the sovereign debt crisis. The financial sector makes up 22% of this index so stress in this sector will weigh on the overall index.

As you can see on the chart below, the current and estimated P/E has dipped to late 2008 levels, at the peak of the Lehman’s crisis. Thus prices are extremely low relative to earnings for Europe’s top 50 blue chip stocks. The one thing we would point out is that in 2008/2009 P/E ratio for the pan-European index fell below 9 for 6 months, so just because something is cheap doesn’t mean that buyers will start to flock in.

The SPX 500:
This index is coming under pressure as the macro environment deteriorates, however it is only down 7.5% since the start of the year. So while the US is affected by the Eurozone debt crisis, its banks are considered more immune since they hold less European sovereign debt than their peers across the water. However, US banks’ exposure to European banks is quite high due to CDS’s and sovereign debt insurance they have written on European banks’ sovereign holdings. This could leave the SPX 500 vulnerable in the event of a default in the currency bloc since the finance sector makes up 14% of the entire index.
However, although the SPX 500’s price has held up better than its European counterpart, its companies have had a bumper year for earnings and right now analysts still expect earnings to hold up in 2012. This has kept its P/E ratio low and it too is close to the levels reached back in 2008/09. Right now European stocks look cheaper than US stocks, since the SPX 500’s P/E is currently at 12, compared to below 9 for the Eurostoxx 50.

To conclude, it’s always difficult to predict when a stock is “cheap” especially in the current environment when there is such political uncertainty and fears about global growth.

It seems fair that European stocks are “cheaper” than US stocks right now since growth in the currency bloc has dropped dramatically. While not stellar, the US economy is still holding up fairly well and is expected to grow at a faster clip of 2.4% next year, relative to just 0.5% for the entire Eurozone in 2012.

However, we believe that growth and confidence are all being supressed by political instability in the Eurozone and the on-going sovereign debt crisis, if that could be fixed then we could start to see European stocks start to outperform as confidence, and most importantly buyers, rush back into the markets. Added to that political risk will heat up in the US next year as Presidential elections take place in November.

Thus, Europe is still vulnerable to further bouts of market volatility for as long as the sovereign crisis remains the biggest macro focus. However, there is definitely event risk coming up for the US next year, so investors need to be on their guard.