Yesterday I said All the charts are pointing up – invest in Europe!
Today I want to unpack that idea some more. Because it seems to me Europe is really in a sweet spot at the moment.
First and foremost, European markets are still nice and cheap. You don’t need to fork out 25 times earnings to bag a good company.
Yesterday I said:
The CAPE ratio is a crude measure of how expensive or cheap a country’s overall stock market is. According to CAPE, the US trades at an extraordinarily expensive 27.5 times cyclical earnings. Not so in Europe. Spain and Italy trade at a CAPE of 13, France at 19, and Germany at 19 also. In other words, eurozone stock valuations still have plenty of runway ahead of them.
Why are European stocks so cheap? There’s a “euro crisis discount” going on. In other words, there’s a small but real chance the eurozone could collapse in a giant financial crisis. And that’s dragging valuations down.
You could see this during the French election. Le Pen wanted to take France out of the euro. Even having been elected, actually pulling out would have been a tall order. But the markets still took the threat very seriously because aeuro breakup would be such a disaster.
As I said last month, Goldman Sachs has estimated that every 10% rise in the likelihood of Le Pen winning the French election meant the euro dropped 2¢ against the dollar. And on the news that Macron had beaten Le Pen in the first round, the French, German, Italian and Spanish markets rallied by an average of 4%.
That’s the euro crisis discount in action. It weighs down all eurozone stocks.
And there’s good reason to think it’s on its way out.
The end of the discount?
I won’t get into the weeds here about the euro’s problems. They boil down to this: when one half of the eurozone is booming (ie the north), and the other half is in a recession (ie the south), there’s no way of bringing the two back into balance.
In most countries, the solution is for the booming part of the country to send money to the troubled part of the country. But for political reasons, that’s been off the table in Europe. Germans don’t want to send money to Greeks and Italians. And German politicians have blocked it at every turn.
That finally looks like its changing. The week before last, Merkel suggested she’d be open to a eurozone budget for the first time. If the idea goes through, it would go a long way towards solving the eurozone’s problems… and getting rid of the euro crisis discount on European stocks.
It’s all coming together
So what do we have so far… we have a) cheap valuations on European stocks and b) the prospect that the euro’s problems might be going away, which would lift share prices across Europe.
On top of that, we have the fact that the European economy is growing at nearly three times that of the US according to the most recent figures: 2.0% annualised versus .7%. Okay 2% isn’t gangbusters growth. But it’s decent, and it’s trending in the right direction.
Lots of other bits and pieces contribute to the overall picture. Car sales are way up. Consumers are confident. Factory managers confidence is at a record high. Italy is starting to wake up. Half EU countries have the highest employment rate in a decade. Peripheral countries like Greece and Finland, which have been in recession for years, are starting to grow. Foreign investors are ploughing into Europe: $7bn has been put into eurozone exchange traded funds this year. Wage growth is starting to pick up.
The strongest performing European economy of the lot is Sweden… which is exactly where I happen to have uncovered a juicy little mobile gaming stock. Click here for the lowdown.
The market is warm. It’s getting hotter. Buy Europe!