European stocks are poised to outdo their American peers. These catalysts explain why.

By Jules Rimmer

JPMorgan and Panmure both prefer European stocks versus the U.S., but for different reasons

JPMorgan sees 5-10% upside in Eurozone stocks to year-end and Panmure expects much better returns from Europe in the next decade, compared to the U.S.

Two separate investment banks had one message for investors on Monday: it's time to switch exposure from the U.S. in favor of Europe.

The research reports, from JPMorgan and Panmure Liberum, offer different motivations for the exchange. JPMorgan's Mislav Matejka presents a tactical, short-term argument, whereas Panmure's Joachim Klement highlights the long-term implications of the extreme valuation disparity between the U.S. and Europe or the U.K.

It should be emphasized that Matejka, JPMorgan's head of global and European strategy, hasn't turned negative on U.S. equities. He says straight up: "Mag7 MAGS and SOX SOX are not a sell." He expects the second half of the year to feature broader market participation with more rotation, after very narrow market leadership from AI, tech and chip sectors in the second quarter.

He's overall constructive on global equities then, but Europe is where he finds the most persuasive case for second-half performance. The benchmark STOXX 600 index XX:SXXP has already reached the full-year target he set last November of 630, returning 13% so far and he reckons another 5-10% upside is still available. His year-end objective is now 680, which is 7% above current levels.

Eurozone has done well ahead of the conflict starting. If geopolitical headwinds continue being priced out, and if broadening materializes, the better performance should resume, says JPMorgan.

The reason for Matejka's optimism is that earnings growth in Europe is picking up, and has been in the last three months, despite the well-advertised vulnerabilities of the Eurozone economy to the energy shock caused by geopolitical turbulence. After three relatively pedestrian years, European stocks may generate earnings growth of 18% this year and 27% next. That's better than the 16% and 19% the U.S. is likely to offer, according to FactSet estimates.

Because of this growth inflection, European stocks can remain on a 15 times price-earnings multiple and still trade higher, Matejka argues. Oil (BRN00) falling to much lower levels than consensus expects and a resultant lowering of bond yieldsBX:TMBMKDE-02Y could drive European stocks further to outdo their American peers.

Matejka and team recommend long beta therefore, (stocks that amplify market moves in either direction), and consumer plays, but they anticipate downside to energy stocks as crude declines, and they believe the outperformance of defense stocks has run its course.

For Panmure's investment strategist Klement and his colleague Francisca Reis, the rationale for switching horses from the U.S. to Europe is chiefly based on valuation. They point out that the cyclically-adjusted price-earnings ratio for the U.S. has now exceeded 40 times again, for the first time in 26 years and now stands at more than double that of European stocks. "This is the widest valuation gap we have seen."

The U.S. CAPE ratio is clearly in bubble territory again, says Panmure.

They observe that even at the zenith of the dotcom bubble in 2000, eurozone stocks were only at 30 times by comparison.

"What makes things worse, in our view, is that these extreme valuations in the U.S. stock market reflect elevated prices at a time of cyclically extreme earnings," said the Panmure team. Going back as far as 1900, in the last twelve months alone, S&P 500's earnings have jumped from 26% above trend to 57% and yet earnings multiples have continued to expand, they noted.

This leads Klement and his colleague to conclude that the U.S. bubble is even larger than it appears. The reason for concern, and what should urge investors to take note, is that the CAPE ratio has a decent track record of indicating future returns. That metric divides an asset's price by the average of ten years of earnings and adjusted for inflation.

Looking at historical trends, Klement calculates the expected returns from U.S. stocks standing at these valuations are minus 2% over the next decade. This compares to Europe's projected 6.3% and 3% in the U.K.

-Jules Rimmer

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.