U.S. stocks are trading at more expensive valuations compared to European equities. The SPDR S&P 500 ETF Trust SPY carries a forward Price-to-Earnings (P/E) ratio of 21x, standing 50% higher than the SPDR EURO STOXX 50 ETF FEZ.

Bank of America analysts Ohsung Kwon and Savita Subramanian suggested the initial sticker shock from the S&P 500’s valuation may not tell the whole story.

“We hear ‘the S&P 500 is egregiously expensive vs. Europe.’ At first glance, it is true,” analysts wrote.

Yet, the valuation premium of U.S. stocks over European equities is not as straightforward as it appears. Once adjusted for sector composition and taking into account growth differentials, energy security and the potential from the AI investment cycle, the premium is largely justifiable.

US Stocks More Expensive Than European Ones? Here Is The Reason

According to their analysis, three-quarters of the S&P 500’s valuation premium can be attributed to the index’s heavier weighting in asset-light sectors, such as Technology. Once adjusted for sector composition, the premium narrows to a mere 12%.

This adjusted premium is closely linked to the growth differentials between the U.S. and Europe.

The current 12% premium implies that the U.S. economy is expected to outperform the European economy by 2.6 percentage points this year, aligning closely with forecasts (+2.7% for the U.S. vs. +0.4% for Europe).

Factors like energy security and geopolitical risks further contribute to a more stable growth outlook for the U.S., supporting the valuation premium.

The current premium of 12% implies the U.S. economy is outgrowing the European economy by 2.6ppt this year, just slightly higher than our house forecasts of +2.7% vs. +0.4%, respectively. Energy security in the U.S. is also a major advantage over Europe, especially with brewing geopolitical risks.

“We believe the better (and likely more stable) growth outlook in the U.S. justifies the premium,” analysts said.

Moreover, a burgeoning AI investment cycle in the U.S. is anticipated to drive a robust earnings cycle over the next few years, with projections of +12% in 2024 and +10% in 2025. This contrasts with a more tepid outlook for Europe, where a 9% decline in earnings per share (EPS) is expected in 2024, followed by a modest 3% growth in 2025.

Historically, the S&P 500 has demonstrated stronger and more stable earnings growth as compared to European stocks, with a 7.3% annual EPS growth over the past decade — nearly double Europe’s +3.8%/yr. The S&P 500 has also seen lower earnings volatility, with the standard deviation of earnings growth dropping to 8% over the last decade, compared to 18% for Europe.

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