the MSCI Europe index yields 5.5%
That’s according to the analytic services company Factset, in a news release about a week ago. Yes, the data are from the end of April, so they’re a bit dated and may be off slightly. But, still…
Why so high?
1. investor preferences
Historically, investors in European equities are much more income oriented than those in, say, US or Asian shares. In fact, “growthier” European companies, which tend to plow back the cash from operations into expanding their businesses–rather than paying it out in dividends–may try to go public in venues like New York or Hong Kong instead of on their home ground. Doing so gets them a more sympathetic/compatible audience, and therefore a higher price earnings multiple (meaning a lower cost of equity capital).
As a result, the European bourses are top-heavy with bank and telecom shares. The former yield around 12%, the latter about 8%.
2. the ongoing financial crisis has beaten down European stock markets…
…which have declined sharply over the past year.
Consider what current dividend yields in the EU are saying today:
–Two-year government bond yields in Germany and the Netherlands are currently slightly negative. In both cases, you have to pay €1001 today in order to get €1000 back in July 2014. Buying a telecom stock instead gets an investor an income pickup of over 8%–an extraordinarily high amount.
–Over the past ten years, the yield on the MSCI Europe index has averaged 4% It has only been higher than today on one occasion–a brief period in early 2009, when panic selling of equities pushed the yield to 6.5%.
–The dividend yield on MSCI Europe is typically higher than that on the S&P 500. The current 3.5% spread is, however, the widest gap seen in the past decade.
what does this mean?
On the most basic level, the numbers say to me that European equity investor confidence is completely shattered. At the nadir for world stock markets in early 2009, German two-year bonds were yielding 1.5%. The MSCI Europe was yielding 6.5%. So the spread between the two was 5.0% then.
Today, the spread is 5.5%+.
Buying the MSCI Europe index, which would return 11% over two years, assuming no change in either stock prices or dividend payments. Investors are choosing instead the safety of a German bond that they are assured of losing money on.
Put a little differently, the expectation built into today’s stock prices is that they will lose more than 11% over the next two years, wiping out the entire yield pickup–and more. This would presumably come through some combination of dividend cuts and price declines.
Shades of Japan in the 1990s!
what to do
This view strikes me as excessively pessimistic.
Nevertheless, this doesn’t mean Europe is a screaming buy. The experience of Japan since 1990 may also be applicable here.
To my mind, there are several lessons that may be appropriate:
–although extremes of fear can’t be sustained, at least mildly negative views about equities can persist for a surprisingly long period, especially when the domestic investor base is relatively old and therefore particularly risk averse
–negative sentiment affects the prices of all stocks in a given market to some degree, not just the basket cases
–companies whose main virtue is their high current yield are probably not going to be the big relative winners. In my view, and also the way I read developments in the Japanese market over the past twenty years, the real winners are well-managed companies which are growing quickly and whose profits come mainly from non-domestic (meaning, in the case of Europe, non-EU) sources. Better if they pay a current dividend, but the rate of earnings growth is more important.
Feeling for a bottom in Europe is not a task for the faint of heart. Nor is it anything one should do with more than a small fraction of his portfolio. Still, it seems to me that we’re at, or near, a degree of negative sentiment that’s excessive and can’t be sustained for long.