The US premium: American exceptionalism, or a triumph of index composition? A comparison between the Stoxx-Europe 600 and S&P500 indices

The chart below highlights this point, with the Stoxx Europe 600 (as proxy for European equities) index forward P/E lagging well below the S&P500 today. The US index has tended to trade at a premium vs Europe over time, but today the difference is stark.

Figure 1: Forward P/E multiples compared: S&P500 vs Stoxx-Europe 600

Many commentators will attribute this phenomenon loosely to “American exceptionalism,” without properly defining what that means. We would offer the following qualitative points:

• Natural advantages, for example:
  • The United States is a huge country bordered by two oceans, is not surrounded by enemies and has (relatively) good relationships with its neighbours to the north and south.
  • Vast amounts of arable land make for productive, low-cost (highly mechanized) agricultural output at scale. The US is second only to India in respect of size of arable land (150 million hectares) but is far more mechanized. The US Midwest has optimal soil and climate conditions for wheat, soy and corn.
  • Extensive river systems (eg Mississippi & Great Lakes) provide an advantage for trade and the cost of moving goods. The Mississippi and its tributaries provide >22,000km of navigable waterways, linking 31 states to the Gulf of Mexico.

• Favourable demographics: the US has benefited from immigration for many years and remains seen as a leading destination of choice for the world’s best talent. This helps keep the country’s demographics favourable relative to many other ageing, Western nations.
• A deep-seated culture of entrepreneurial risk-taking and innovation – this is hard to exactly define, but Americans do not seem to regard failure in the same negative light (a blight on one’s character?) as many other countries’ societies do. Why does Europe and the UK, for example, not have their equivalent “Silicon Valley?” We would posit that this has nothing to do with intellectual capacity, but rather the broader societal ecosystem which either supports risk-taking, regards early failures as a reason to try again and innovate, or rather casts judgement on those who attempted to “break out of the mould” and didn’t succeed.
• By contrast, we would highlight that the EU appears to be far more bureaucratic in its approach to business. A recent example would be the region’s attempt to regulate AI – a relatively new innovation – rather than to encourage its development.
• A large, relatively homogenous market – the US population is around 340 million and could be regarded as a single market, whereas the EU (~450 million people) – while a single union – consists of more diverse individual markets with varying levels of development, tax rates, regulations, societal norms, tastes and preferences. It may be more challenging for individual businesses to scale their business models or ideas across multiple European markets as opposed to multiple US states. The European Union is a much newer union than the United States of America.
• Rule of law and respect for private property (including intellectual property) – this is often taken for granted (especially the latter) and would also be common to many European nations. But many emerging market countries cannot claim to abide by these principles. Capital formation and investment is difficult (impossible?) to achieve in the complete absence of these factors.

The above list is by no means exhaustive but provides some insight into what we interpret American exceptionalism to mean. However, this doesn’t yet fully answer the key question at hand: why do US equity indices trade at such a premium – and more so than in the past. Furthermore, is this premium justified, or does the market have it wrong?

Stoxx-Europe 600 vs S&P500: breaking it down to index level

The immediate observation we make from a cursory analysis of the two indices is that sectoral weights differ markedly today between the S&P500 and the Stoxx-Europe 600. Put simply, the US is heavily overweight “growth” sectors (such as Information Technology, Communication Services), while Europe is heavily overweight “Value” sectors such as Financials and Industrials.

Figure 2: Sector weights: US vs Europe

The second observation one can make is that the US equity market is far more concentrated than European indices – this has been a creeping phenomenon for a while, and we believe is due to the prevalence of a high (and growing) concentration of “global champions” in US indices which have exhibited “winner take all/most” economics (as evidenced by much higher than average returns on equity too). Europe, by comparison, has a relative lack of these firms. On this list, Nvidia is a relatively new phenomenon– its market cap is now $3.5 trillion, up ~10x from just two years ago. It has earned this right due to its dominant position in the supply of GPU chips powering the AI arms race. As it stands today, no other company comes close – and all the main contenders are in the US.

Figure 3: Top 10 stock weights, P/Es & returns on equity: Stoxx-Europe 600 vs S&P500

In the table below, we compare the Stoxx-Europe 600 index to the S&P500 by sector and include weightings, expected EPS growth, together with the PEG ratios (P/E divided by earnings growth rate).

Figure 4: Stoxx-Europe 600 vs S&P500: sector fwd P/E, EPS growth and PEG ratios compared

In the table above, we re-weighted each stock in the Stoxx-Europe 600 as a proportion of each sector (i.e. assuming each sector totaled to 100%) together with each company’s earnings yield to arrive at multiples for the sector; for the S&500, we used the sector ETF weightings for each stock (per SPDR) in our analysis. All earnings estimates are per Refinitiv.

If one were to apply “European” sector weights to the S&P500, the latter’s forward P/E multiple would be around 0.8x lower than it is. This would still not fully account for the dramatic difference in ratings between the two indices. When we introduce the consensus expectations of earnings growth to be delivered, some of the differences are better explained.

Some important observations we would make:

• At an index-wide level, the S&P500 trades at a lower PEG ratio than the Stoxx-Europe 600, as evidenced by the “PEG relative” of 0.91. It should be noted, however, that PEG is a crude measure of valuation, considering one year of earnings growth – and the value of shares and indices is far more involved than simply this years’ expected growth. But on this singular measure, it appears the market has got it broadly right – and in fact one could argue in favour of the US if the gap in growth rates
• There are accounting differences to be aware of: sharp-eyed readers will notice that the US Real Estate sector trades at a prospective P/E multiple more than double that of the Stoxx-Europe 600’s Real Estate sector. However, there are accounting differences which likely skew comparisons here: under US GAAP, real estate is held at historical cost less accumulated depreciation, where under IFRS, European companies allow for revaluations upward of property values (to “fair value”) to flow through the income statement. So, reported earnings of European Real Estate companies are likely to be higher – even if there is no real economic impact of this accounting difference. Therefore, it is unlikely that the 37x forward P/E multiple for the US Real Estate sector is comparing “apples with apples” when judged against Europe’s 14.4x.
• Sector anomalies: three sectors stand out where the US trades at premiums well more than that seemingly justified by the current year’s expected growth rates: Communication Services, Consumer Discretionary and Consumer Staples. We will discuss these in turn further on in this article.

1. Communication Services:

• Europe does not have any Communication Services global “champions,” such as Meta or Alphabet. We define a global champion as being dominant in a large industry globally, not just regionally. These two companies collectively command around 70% of global digital advertising revenues, making it clear their tentacles have extended far beyond their home markets to dominate the global advertising profit pool. Non-US stock markets lose out on the market capitalisation of this (growing) economic opportunity - much of which is taking place in their own back yards. We would argue that their market positions, returns to scale and cash-rich balance sheets comfortably justify the 20x+ forward P/E multiples these companies enjoy.
• Traditional telecommunication companies are overrepresented in Europe vs US: Deutsche Telecom alone accounts for 30% of the Stoxx-Europe 600 sector weight, while these “telco” companies more broadly occupy >50% of the sector in Europe. Note their relatively mediocre return on equity too compared to the US’s Communication Services leading companies. Telecommunication providers in the US account for under 20% of the US Communications sector.

2. Consumer Discretionary: 

• The largest stock in this sector in Europe is LVMH (which trades at a forward 25x P/E), yet occupies 1.5% of the Stoxx-Europe 600, or ~16% of the sector weight. The next two holdings are half the weights, respectively, but also luxury goods companies (Hermes and Richemont). Arguably, Europe could be considered the home of the key global champions of the luxury goods industry. These are good businesses with attractive pricing power but operate in a highly cyclical industry.
• By contrast, the US has Amazon and Tesla as the two largest weightings within Consumer Discretionary, accounting for ~40% of the sector’s weight. These two companies trade at 12-month forward 38x and 137x P/E multiples, respectively.
• While Europe could reasonably lay claim to owning the luxury goods global champions, Amazon as a single company is far more important economically – its annual revenue in the e-commerce business alone exceeds the entire global luxury goods industry (Amazon’s non-AWS revenues likely exceeded $380bn in 2024), while AWS is the largest cloud computing platform in the world, servicing customers all over the globe. Outside of China, the other major global Cloud players hosting large datacenters for Western customers also happen to be US companies. Europe possesses no comparable “Amazon.” Importantly, Amazon has had a long track record of aggressively investing through its income statement, thus suppressing the company’s true earnings potential for years. The high forward P/E multiple should also be viewed in this context.
• The “Tesla factor”: Given Tesla’s weight and very high valuation, its index influence is profound: if it were, instead, trading at, say, a forward 10x P/E multiple (higher than traditional autos, but we would argue it deserves much higher – that’s a discussion beyond the scope of this article), the US Consumer Discretionary sector would be trading 7.4 multiples lower at 17.6x forward P/E, while the entire S&P500 would be trading at 20.7x – around 1x P/E lower than the actual multiple.
• Legacy automakers are over-represented in European indices vs US: European auto-makers account for 12% of the Consumer Discretionary sector in Stoxx-Europe 600 and these companies trade at very low valuations (likely justifiably so; 5-6x P/Es in most cases). By contrast, GM and Ford also trade at similarly low P/Es but only occupy around 3% of the S&P’s Consumer Discretionary sector. The Stoxx-Europe 600 Consumer Discretionary sector would trade at 3-4x P/E multiples higher if it had the S&P500’s weighting of legacy auto-makers; this factor alone accounts for around 1/3 of the difference in rating of the Consumer Discretionary sectors when comparing US to Europe. Adjusting for Tesla’s idiosyncratic influence would basically close the gap

3. Consumer Staples:

• Staples feature more highly in Europe than the US indices (10% vs 6%) and Nestle accounts for the largest European holding at ~20% of the sector. This is the one sector where we would argue that, even adjusting for growth rates and returns on equity, Europe looks cheap vs USA.
• Costco and Walmart stand out as outliers that skew the US sector valuation materially – especially considering expectations for 10-12% earnings growth for each. These two companies account for 20% of the US staples sector, and trade at 48x and 34x forward P/E multiples, respectively. We think Costco is an incredible business (its membership model with the cost benefits of scale passed on to consumers in price is a model of customer loyalty), but it has materially re-rated in recent years without a concomitant change in long term outlook. If both companies traded at the average European sector multiple (i.e. 14x), the US sector multiple would drop from 18.2x to 15.6x – much closer to the Stoxx-Europe 600 Staples multiple.

Notably, Information Technology is one sector where the US enjoys no sector-specific rating premium vs Europe – despite the prevalence of obviously globally dominant “champions” (e.g. Apple, Nvidia, Microsoft). This is even more apparent given the perception many investors have of a US premium vs Europe being attributable to “expensive US tech shares.” This is likely because, while Europe’s tech sector is much smaller (7% of Stoxx-Europe 600), it is highly concentrated in their one own global champion – ASML - which is a global market leader in the production of multi-million-euro EUV machines used in semiconductor foundries to produce microchips.

• ASML and SAP - 63% of the European tech sector – trade at 31x and 42x PEs, respectively.

Return on equity considerations

Valuations are not just about earnings, but also how capital efficient companies are in generating their earnings. The simplest metric in measuring this is return on equity, which is net profit expressed as a percentage of a company’s net assets on its balance sheet. In other words, how many units of capital are required to generate one unit of profit.

In this regard, it is clear from the above examples across these sectors that US companies tend to stand well clear of their European counterparts, which no doubt goes a long way in explaining valuation differentials. In the final analysis, ROE determines how rapidly a company can grow and / or how much capital it can return to shareholders – both critical pieces of the valuation puzzle.

Macro considerations

Aside from industry-specific issues and index constituent nuances, one cannot ignore the growth differential which has emerged in recent years between the United States and Europe.

Figure 5: GDP growth rates

As shown in the above chart, the US has generally delivered economic growth more than the Eurozone, but this gap widened sharply from the end of 2022 – this likely coincides with the negative impact of the Ukraine war on Europe’s energy costs, and the concomitant knock-on effect to the cost structure of industrial exporters. Germany has been especially hard hit. This time frame of divergence of economic growth coincides with the divergence in index valuations.

Conclusion

Europe’s equity indices trade at a meaningful discount to the US. This is a function of:

1. “American exceptionalism” as defined earlier – many advantages the US has are natural and likely to persist.
2. Index composition (European indices are over-weight ex-growth sectors such as Staples, as well as subsectors such as auto makers, while being underweight higher-rated sectors such as Information Technology).
3. The relative lack of true global champions (outside of luxury goods) in European indices.
4. Structurally higher returns on equity in US businesses – in turn, this is likely a function of better global scale in US mega corporations, as well as more shareholder-friendly management style and capital allocation.
5. Far superior current and expected earnings growth in the US – as measured by PEG ratios (admittedly a single, crude measure of relative value), the US is actually cheaper than Europe.
6. Economic growth falling persistently short of the US – and more so in recent years.

We believe, however, that a case could be made for a cyclical rebound in European economic growth should, for example, a resolution be found to the war in Ukraine. This would have beneficial knock-on effects to energy prices, helping to lift earnings of industrial producers. One could well argue the case for a narrowing of the discount of European equities vs the USA if this occurred.

However, more structural impediments to long-term trend growth such as the challenge of China’s EV auto-makers to legacy car producers in Europe, a bureaucratic EU legislative framework (especially as it pertains to regulating rather than encouraging innovation in new vectors of economic growth such as AI), a more rapidly ageing demographic than the US and less flexible labour markets are likely to prove more intractable problems.

For now, Europe remains the “value” index and the US needs to continue delivering on earnings growth given the valuation differential. DM