European vs US Equity Markets

In this article, we will analyze the impact of the conflict in Ukraine on the European market compared to the US market.

Differences between the US and European economies?

First, let us look at the fundamental differences between the European and American economies:

• The US is one of the top three producers of oil and gas, while Europe is highly dependent on energy.
• The FED has already hiked rates sharply while the ECB started much later.
• A larger share of Europe's market capitalization is in energy-intensive sectors such as Manufacturing and Materials, while the US has a larger share of its market capitalization in Technology.

Based on these data, we can assume that Europe and the US are asymmetrically affected by the current crisis.

Sector comparison S&P 500 vs Stoxx 600

How does the market price this difference?

We have seen the structural differences between both economies. We will now look at the short term market data:

• P/E ratio is ~12x in Europe vs 18x in the US. While the US market is historically more expensive, Europe is at a historically low level.
• Volatility: the VSTOXX (Eurostoxx50 implied volatility) peaked higher than the VIX (S&P500 implied volatility) at the beginning of the conflict.
• However, the two volatility indicators are now aligned, which means that market participants now assume the same risk premium for both markets.

European markets are currently trading at a discount compared to the US, but the volatility is similar in both markets.

S&P500 implied volatility vs Eurostoxx50 implied volatility

Volatility spread (Europe minus US)

Is there a specific European risk?

Macroeconomic data has been one of the main drivers of market sentiment recently as investors await the much anticipated FED pivot.

However, there appear to be various Europe-specific risks:

• Eurozone companies' costs have risen by 43.3% this year, according to Eurostat, more than double the US level, which could generate a margin squeeze.
• Due to rising energy costs for households, pressure on wages could be increased. A recent example is Stellantis in Italy where unions are demanding a wage increase of 8% for 2023.
• Although hypothetical, potential power cuts and gas rationing could shut down some industries in Europe, which would have a devastating effect on the valuations of these companies.

Conclusion

The Q3 results will be key for the equity market, and we will see how the market reacts in the coming weeks.

There seem to be some Europe-specific risks reflected in valuations, but the volatility regime is now the same for Europe and the US.

Only time will tell how the situation will evolve.