Despite the barrage of quantitative easing measures introduced by the European Central Bank, eurozone equity risk premium stands at 6.5%, the NN IP analysis revealed.
Relative to the risk premium of US equities, which has been on the decline for multiple years, the implied cost of eurozone equities currently remains 80 basis points higher.
The greater degree of investor confidence in US equities in recent years has undoubtedly been propelled by “lower treasury yields and a stable equity risk premium,” said Patrick Moonen, principal strategist in NN IP’s multi-asset department. And it further reinforces the perceived political fragility in the eurozone, he said. “Flaws in the institutional framework, a burdened banking sector, political uncertainty and Brexit explain the reluctance of investors to buy eurozone equities. On top of that, eurozone earnings growth has lagged US earnings growth with the exception of 2015.”
And while the ECB’s attempts at monetary easing have been more successful at tightening credit spreads in the eurozone’s bond markets, they have not done much to assuage investor anxieties around eurozone equities, he added.
However, Moonen thinks that encouraging higher nominal GDP growth through more fiscal and monetary policy coordination could reverse the fortunes of eurozone equities.
He also anticipates that pressure on US profit margins from rising wages or a rate hike from the Fed could make US equities appear less attractive, thereby reducing the risk premium of eurozone equities.
“US profit margins could come under pressure from rising wages given the trends in the labour market,” he said. “Finally, a US rate hike could push the cost of equity higher or pressure the net profit margin.”
While there are several factors that could alter the risk premium of US and Eurozone equities, Moonen said “it may take some time for these to come into play.”