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The combination of positive fundamentals (return to pre-crisis corporate profitability, negative real long-term interest rates) and the effect of growth in the quantity of money on share prices suggests that European equities are currently cheap, according to economists at Natixis. 

Key quotes

“After the subprime crisis, earnings per share on the Euro Stoxx regained its pre-crisis trend. Companies are able to rapidly regain their pre-crisis profitability in particular by curbing wage increases.”

“PERs are expected to be high, as real long-term interest rates will remain negative, despite the expected slowdown in potential growth and a persistent rise in the equity risk premium. But as inflation normalises and nominal long-term interest rates remain very low, real long-term interest rates should be highly negative in 2021 (around -1.5%), driving PERs higher.”

“The price-to-book ratio is low relative to the past, which shows that equity market valuation is abnormally low.”

“The ECB’s monetisation of fiscal deficits will lead to strong growth in the quantity of money, which concerns both central bank money and money held by non-bank economic agents. It will also trigger a portfolio rebalancing effect: as the weight of cash in portfolios is too high, this money will be reinvested in other asset classes, including equities, driving up their prices. A return to previous portfolio weightings, given the pressure of the quantity of M2 money held by non-bank economic agents, would lead to a rise in share prices 20%, on top of that resulting from fundamentals.”