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Jeffrey Kleintop, CFAChief Market Strategist

LPL Financial

LPL F INANCIAL RESEARCH

Weekly Market CommentaryJuly 30, 2012

Are European Stocks a Good Value?

Highlights

Given the plunge in European stocks over the

past year, are European stocks a good value?

We doubt it.

In general, European stocks are not

inexpensive relative to U.S. stocks. This

is because earnings per share in Europe

have been alling along with prices, keeping

price-to-earnings (PE) ratios rom oering an

attractive discount.

European stock markets overall have allen this year and plunged by over

20% during the past 12 months, measured in dollar terms using either the

MSCI Euro or Euro Stoxx 50 indexes. At the same time, U.S. stocks have

posted solid gains. While Europe is in an economic recession and clearly

aces fscal challenges, has the market ully adjusted or these concerns, or

even over-reacted, creating a contrarian investment opportunity or U.S.-based investors? In other words, are European stocks a good value? We

doubt it.

In general, European stocks are not inexpensive relative to U.S. stocks. This

is because earnings per share in Europe have been alling along with prices,

keeping price-to-earnings (PE) ratios rom oering an attractive discount.

Generally speaking, European stocks typically trade at about a 20% discount

to U.S. stocks. With European stocks at a PE ratio o about 11 and U.S.

stocks at 13, European stocks are not at a discount to their historical relative

valuation to U.S. stocks [Figure 1]. In act, U.S. stocks are 5% cheaper

relative to their long-term average PE ratio than European stocks.

The reason Europe is not getting cheaper is that Europes labor rules mean

that when output drops, European companies cannot cut their labor costs to

the same degree as U.S. companies can. With higher fxed costs than U.S.

companies, European corporations see more o a reduction in earnings than

headcount when revenues all.

Markets PE Ratio

France 10.0

Germany 9.7

Greece 8.6

Ireland 21.4

Italy 8.2

Portugal 10.3

Spain 9.7

UK 10.3

Average 11.0

United States 13.1

Source: LPL Financial, FactSet Research Systems 07/27/12

1 PE Ratio by World Market

U.S. stocks are 5% cheaper relative

to their long-term average PE ratio

than European stocks.

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Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

This research material has been prepared by LPL F inancial.

To the extent you are receiving investment advice rom a separately registered independent investment advisor, please note that LPL Financial is not

an afliate o and makes no representation with respect to such entity.

While the Eurozone unemployment rate has risen, despite being in

recession it is only about 1.5% higher than it has been on average over

the past 20 years. By comparison, in the U.S. where growth continues, it

is 2.2% higher. Even more directly as it relates to profts, the labor cost toproduce a unit o output has risen much aster in the Eurozone over the last

decade and continues to rise through the downturn in countries such as

Italy, France, and Portugal (as you can see in Figure 2). At the same time,

labor costs per unit have remained much tamer in the United States. With

labor generally comprising about 70% o business costs, this can have a big

impact on profts.

While European stocks are likely to present an attractive investment at some

point, their values do not compensate or the heightened risk to corporate

profts as the Eurozone struggles to defne its uture economically, politically

and socially. n

IMPORTANT DISCLOSURES

The opinions voiced in this material are or general inormation only and are not intended to provide specicadvice or recommendations or any individual. To determine which investment(s) may be appropriate or you,

consult your nancial advisor prior to investing. All perormance reerence is historical and is no guarantee o

uture results. All indices are unmanaged and cannot be invested into directly.

The economic orecasts set orth in the presentation may not develop as predicted and there can be noguarantee that strategies promoted will be successul.

The MSCI Europe Index is a ree foat-adjusted market capitalization weighted index that is designed to

measure the equity market perormance o the developed markets in Europe. As o June 2007, the MSCI Europe

Index consisted o the ollowing 16 developed market country indices: Austria, Belgium, Denmark, Finland,France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and

the United Kingdom.

The P/E ratio (price-to-earnings ratio) is a measure o the price paid or a share relative to the annual net

income or prot earned by the rm per share. It is a nancial ratio used or valuation: a higher P/E ratio meansthat investors are paying more or each unit o net income, so the stock is more expensive compared to one

with lower P/E ratio.

International and emerging market investing involves special risks such as currency fuctuation and political

instability and may not be suitable or all investors.

Stock investing may involve risk including loss o principal.

2 Labor Costs Are Stubbornly High in Many Eurozone

Countries Relative to the United States

Source: LPL Financial, Bloomberg data, Organisation or Economic

Co-operation and Development (OECD) 07/27/12

01 02 03 04 05 111009080706 1200

1.5

1.4

1.3

1.2

1.1

1.0

0.9

United States

Spain

France

Italy

Portugal

Labor Cost Per Unit of Output by Economy