Opportunities in Europe

Casual observers wouldn’t have missed the fact that European markets haven’t fared as well as those in North America in recent years.  At one point, the Dow was up around 250% from its low point in the midst of the Great Recession.  Whilst the German Dax and the UK’s FTSE did briefly touch all-time nominal highs, they haven’t performed quite as well.  Adjusted to inflation, the market price at the height of the dot com bubble were higher.

There are a number of reasons for this.  First, the US economy has consistently outperformed most major economies until a few years ago.  This was helped by the Federal Reserve’s Quantitative Easing program, which also fed into markets by improving company balance sheets – especially the banks.

Times have changed, however.  In the last 2 years, the UK has been the world’s best performing G7 country, averaging growth of around 3% per year.  Some of `sick men` of Europe have also showed signs of improvement, with Ireland recording 5% growth and Spain just behind.  The European Central Bank has finally, moreover, started to interfere in the bond markets just as Federal Reserve appears to be considering tightening.

Importantly, there does seem to be a lot of value in Europe.  I was looking at an incredible statistic in Hargreaves Lansdown recently.  The cynically-adjusted price to earnings ratio is now lower than it has been since the early 1980s.  In 2007, before the economic crisis, it was at 35, and the average has been 22.  Now, we are trading at around 12.  Such data should not be considered in isolation, but it does illustrate that Europe, alongside Japan and some emerging market, is starting to offer more value than North American equities.

In the short-term, markets are often moved by speculation, such as the dramas in Greece and China.  Ultimately, people shouldn’t forget that the European Union has a bigger economy than even America, and the types of companies that exist there are global firms that can be profitable even when markets at home are depressed.  Take a company such as AXA, originally a French company, but which now generates most of its income overseas. If the Front National win an election in France or the ECB puts out the wrong signals in relation to monetary easing, its share price, like all French equities, would get hammered, like the rest of the Eurozone and possible European shares in general.  This is despite the fact that such factors would barely dent its profitability in a global economy.  As ever, investors should bare in mind that they should be brave when others are fearful.

Greece – a buying opportunity?

The current events in Greece has had side-effects on the world’s equity markets.  The FTSE and many European markets are about 10% below the highs they had previous hit earlier in the year.  The Chinese market is also down more than 30%, although one suspects that has more to do with the bubble that was happening than anything to do with Greece.  Developing markets in general have seen capital flight, as have their currencies, and `safe haven` trades such as US, German and other government bonds are back in fashion, after previously taking a hit.  The US is also up for some of the same reasons.  The question is, is this a buying opportunity?

The first thing to remember is that one can’t time markets.  For the average investor, it makes sense to invest when they can, either monthly, or in lump sums depending on their financial circumstances, and wait it out for the long haul.  Equity markets should rise over time.  It is very easy for investors to keep to much money in cash waiting for the `perfect` opportunity to invest, when in reality, nobody has a crystal ball.  Very few people could have predicted what has happened in the world in the last 5-10 years and there are always some known unknowns and unknown unknowns.

What this crisis is once again showing, however, is the importance of being diversified and invested in numerous asset classes.  If the crisis gets worse, government bonds will go up in value, and equities down.  Therefore, it is possible to reallocate away from the bonds and into the equities.  Using the Warren Buffett rule of being optimistic when others are fearful and vice versa, investors can take a rational, pragmatic and long-term approach to their portfolios and reap the dividends.

Having said all that, it is important to look towards markets that are cheap historically and in terms of price-to-earnings ratios and only measures of value.  Even before this last sell-off, emerging markets looked cheap.  They didn’t see the types of consistent double digit growth that the US markets saw after 2008.  With the Greece situation being as it is, it makes some sense to re-allocate 5% of funds towards emerging markets.  Re-allocating every 3-6 months, away from performing funds into under-performing ones is painful, but necessary.