Tag Archives: EU

thinking about 2013

May 31, 2012 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, securities markets, stock market, Strategy Tags: , , , , , , , , , Leave a comment

looking ahead

Today is the last day of May.  In a normal stock market year (let’s define “normal” as a time when investors are neither euphoric nor ready to jump out windows on high floors in tall buildings), this is the time when equity investors begin to ponder what the following calendar year will bring.

Why so early?  No extremely compelling reason.  It’s just the way it typically works.  Equity markets are futures markets, after all.  And by this time participants will have already discounted much of what the current year is likely to bring and are asking “What’s next?”.

not normal everywhere, but definitely normal in the US

Conditions are by no means normal all around the world.  Europeans are scared out of their wits by the politics/economics of the EU.  Pacific Basin markets are keeping a close eye on China, while hoping the battering they’re taking from European selling will soon end.  In the US, in contrast, the economy is entering its fourth year of recovery.  Employment is stable-plus, compensation for regular employees (as opposed to CEOs, who always pay themselves well) is beginning to rise, and the housing market–a key source of wealth–is showing its first signs of life since 2007.  While daily price volatility may be high and the shrill noises from talking heads may be particularly bearish, I think 2012 is a normal year.

therefore, time for pondering 2013 to begin

(You may argue that pondering season has already started, and point to the 8% decline in the S&P since its intraday high on April 2nd as evidence.  I don’t interpret the data that way, but you may be right.  If so, you should be more bullish than I am, since you think Wall Street has been factoring bad news into prices for longer than I do.)

a few numbers

Let’s begin with a back-of-the-envelope (which is the best you’ll get from me) calculation.  According to Factset, Wall Street is estimating earnings of around $105 for 2012, up from $97 in 2011.

Let’s say S&P 500 eps will reach $110-$115 in 2013, which is roughly the consensus.

based on 2012 eps

If the market could trade at 14x earnings, a target for the S&P based on estimated earnings would be 1470.

The 1422 high of two months ago was about 3% below that, giving new money absolutely no motivation to buy stocks.  That also meant short-term traders had a reason to bet against a further rise.

Yesterday’s close was about 12% below 1470, suggesting the US stock market may be on more stable ground.

…and based on 2013 eps

The same calculation gives a target range of 1540-1610 for the S&P based on my guess about next year’s eps.  Potential appreciation from yesterday’s close would be +17% to +23%.

If you want to say that the US stock market continues to trade at the current multiple of 13x eps instead of 14x, then potential appreciation would be +9% to +14%.

In a world of 1.6%-yielding ten-year Treasuries, and 2.7% thirty-years, either case looks pretty good.

clouds on the horizon

I can see three, all of them the obvious ones:

1.  slowdown in China   For what it’s worth, as macroeconomics I think this is old news.  Policy is already beginning to move in a stimulative direction.  However, it will take some time for the new policy direction to take effect.  This probably means weaker prices for industrial commodities–and for commodity-dependent stocks–as well as for negative earnings surprises for firms whose profits are strongly linked to Chinese customers.  So China does have stock market implications.  But they’re stock selection ones rather than market-moving ones.

2.  “fiscal cliff” in the US    On January 1, 2013, the temporary federal payroll tax cut is set to expire.  So, too, is the extension of Bush-era income tax reductions.  Large mandatory cuts in federal government spending, triggered by Washington’s failure to come up with an overall plan for deficit reduction, are supposed to happen as well.

This combination is enough to send the domestic economy beck into recession.

The consensus view is that after the election, the lame-duck Congress will do something to soften the blow.  My guess is the consensus will prove correct, although an accident is always possible.

3.  implosion in the EU    This is the main concern of global stock markets.

To recap:

–The crisis has been going on for almost three years.

–Worries have been discounted in waves of selling over that time, the worst of which (I think) have been the one currently in progress and the previous one last summer.

–The general parameters of a solution have been well-understood for a long time.

–I think Greece being in the EU or out is a big deal for that country but for no one else.

–The end game is unlikely to be a Japan-like fading of the EU into irrelevance, which would be bad for Europeans but ok for world equity markets.  Unaddressed, an outcome more like the 1996-98 crisis in smaller Asian markets is more probable.

timing?

Evidence to date to the contrary, I tend to think that the worst won’t happen.  I’d feel better about markets if I thought I were in the minority.  But if I were, I think global equity prices would easily be 10% lower than they are now.

If I’m correct, the main imponderable is the timing of a solution.  What little I know (or think I know) about politics says that when resolving a difficult issue involves sacrifice, the problem must be seen as so bad that solving it–no matter what the cost–can be presented to voters as a victory.

Are we at that point yet with the EU?  I don’t know.  Martin Wolf, chief economist with the Financial Times, has a good summary of the state of play.

Were the EU to show it finally has the resolve needed to adequately address its financial woes, however, I’m confident that the higher S&P targets for 2013 mentioned above would quickly become Wall Street’s game plan.  And a mini-version of last year’s autumn rally would likely occur.

In the meantime, markets will likely drift.

a second Greek bailout payment agreed: implications

February 21, 2012 By in Current Market Thoughts, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , , , , , Leave a comment

an agreement

Greece and the IMF/EU have finally agreed on conditions for the latest tranche of bailout money, €170 billion, to be paid to the troubled Mediterranean country.  Greece will now have the funds to redeem €130 billion of its bonds that mature in the next few weeks.

little stock market reaction

Stock market reaction in Europe has been muted–a 2% gain yesterday, a give-back of about half that amount today as I’m writing this.

what went on in the talks?

I find it hard to interpret with any confidence what has been going on in negotiations between Greece and the EU/IMF.  It’s possible that the brinksmanship displayed in the talks on the question of whether Greece would remain in the Eurozone was all a show, performed for home country voters by politicians eager to minimize the negative consequences of any accord for their future electability.  But that’s not what I think.  My take is that Greece–which hadn’t come close to fulfilling the conditions of its initial bailout payment–figured until recently that the EU was negotiating from a position of extreme weakness.  Until the EU made it clear it was willing to let Greece leave the Eurozone, Greece felt it could extract almost any concession, provided it didn’t do so all at once but rather moved the bar a little bit at a time.  Once the EU began to plan for a Greek exit, Athens was forced to become serious about striking a deal.

implications

It seems to me that at the very least both sides have bought themselves some time.  I’d expect that the core EZ countries will continue to strengthen the capital structure of their domestic banks.  It’s understandable that potential buyers of the public assets Greece supposedly has on sale would be reluctant to bid until they were sure that they weren’t purchasing just before a significant currency devaluation.  So we’ll now have a chance to see how serious Greece is about these divestitures–and how desirable they actually are.

We’ll also have a chance to see whether the EU will retain its hard line that starving yourself through austerity is the best prescription for a return to robust health, or whether the ECB monetary policy will be a bit looser than it has let on to date. My guess is that it will.

Implications for stock market investors?  I think they’re less about a change in strategy than about confidence that the strategy is correct.  I view the EU as a low-growth area for an extended period of time.  And, although fears of a “Lehman moment” are off the table (not that markets ever really factored this possibility into stock prices), Europe will be subject to periodic worries about weaker EZ countries like Greece.

So the appropriate stance remains, I think, to be underweight the area and to concentrate on companies which are listed in the EU but which have the bulk of their operations located in the Americas or in the Pacific.

what’s that about Japan?

Actually, a much newer and more interesting macroeconomic development has been going on half a world away.  It’s quantitative easing in Japan.  More on this tomorrow.

 

Shaping a portfolio for 2012 (II): Europe

January 5, 2012 By in Constructing a Portfolio, Current Market Thoughts, Foreign markets, Portfolio management, Shaping a portfolio for 2012, Strategy Tags: , , , , , , , , , , , Leave a comment

Europe–I’m not an expert…

I’ve been watching European stock markets for over 25 years, but I don’t consider myself an expert on Europe.  There are too many social and political quirks for me to get motivated to master its intricacies, given the relatively small size of each country, and of continental Europe in the aggregate, in stock market terms.  So I’ve taken an “American” approach and tried to just pick stocks.

…but everyone has to have a plan

On the other hand,  most stock market investors have to have a plan for dealing with Europe, since it’s a big trading partner with China and maybe a quarter of the revenues of the S&P 500 come from Europe.

Even a simple plan is almost infinitely better than nothing.  It gives you a baseline to monitor for signs that the reasoning behind your stock selection is wrong.  Rather than simply watch your stocks go down in flames, you can try to fix the budding problem.

Here’s my take on Europe:

There are a number of political groupings in Europe.  The widest is the EU itself.  Then there’s the Eurozone (all the countries which have adopted the common currency, the €) as a subset of the EU.  And there are other things like the Schengen free travel area.

For investors, the Eurozone is the most important of these.

To my mind, the defining characteristic of the Eurozone is that it has a common monetary policy, but fiscal policy that’s determined by each country.  This is what has the EZ in trouble today.

The ECB sets interest rates at a level that’s appropriate for the EZ as a whole.  For traditionally slower growing countries at the core, like France and Germany, that has arguably been too restrictive.  For faster growing, smaller economies on the periphery of the EZ, the rate has been extremely stimulative.

Easy money sloshing around the periphery found its way into massive numbers of speculative real estate deals.  Of course, each country should have recognized this and restrained speculation through cautious fiscal policy.  But what politician is going to take the punch bowl away from the party?  After all, there’s always an election around the corner.

To some degree, real estate speculation also infected the periphery with the “Dutch disease,” meaning that demand for construction workers drove up wages elsewhere–making other, export-oriented manufacturing industries less competitive.  For Americans, it’s like Detroit and the car industry.

If that weren’t bad enough, two countries, Greece and Italy, decided to game the system.

In my experience, Italy has always been the least economically responsible large country in Europe.  Yes, it took heroic measures to restructure itself to qualify to enter the EZ as a charter member.  But then it fell back into its old slovenly ways.

I’ll confess that I know next to nothing about Greece.  My impression is that it thinks membership in the EZ was a fabulous chance to scam the rest of Europe.  My impression is that it will happily default on its sovereign debt and leave the EU as soon as it gets a chance–sort of like skipping out on a restaurant check.  Luckily, its small size makes it a rounding error for Europe as a whole.

That’s the problem.  But where are we now?

I think we’re past the worst and on the way to fixing the current EZ problems.  I don’t mean the structural flaws in the EZ, but just today’s crisis.

We’re already seeing serious reform out of Ireland and Spain.  Greece and Portugal (another country where I have no clue) are too small to matter.   The real EZ economic uncertainty comes down to what happens in Italy.

Italy went through another painful wholesale economic reform process to enter the EZ and it has appointed economist Mario Monti as premier with a mandate for reform.  I think these are good signs that Italy is wiling to make the necessary changes to its economy once again.

One other point to mention:  a much simpler fix to problems in Italy and Greece would be to have the ECB loosen money policy by, for example, buying up Italian government bonds.  Doing so removes any incentive for Italy to reform, however–so it just kicks the can down the road.  More than that, money policy that’s inappropriately loose for Germany creates the need to use restrictive fiscal policy to offset it.  Angela Merkel certainly doesn’t want to have to do that.

my bottom line

economics

Politicians in any area of the world only seem to me to act when the situation has deteriorated so far that the painful measures they need to implement are greeted with relief by the electorate as a “rescue” from a worse fate.

I think we’re at, or past, that point in the EZ and that the essential measures are already agreed to, through changes in government, that will end the current EZ crisis.

The main means of change will be austerity.  Once the ECB is convinced that Italy is sincere in its reform efforts it may provide some monetary assistance.  But cutting government spending and enforcing tax laws will be the order of the day.

For the European periphery, this spells recession today and low growth for a while after.

stock markets

The bigger question for equity investors is often not so much what the economic reality is likely to be as, rather, what economic scenario is currently being discounted in today’s stock prices.

I have four conclusions:

1.  I think today’s European stock prices discount a more pessimistic outcome than I see as probable.

2. I don’t think that attitude will change, however, until we see changes in EZ laws that are slated for March plus further concrete developments from Rome.

3.  I don’t want to bet the farm on my analysis.

4.  No matter what the precise outcome, Europe is likely to be the slowest growing area of the world in 2012.

Therefore,

I’m substantially underweight Europe.   I hold small positions in a couple of equity mutual funds, and one stock, through its ADR, IHG.  I would prefer Europe-listed companies that have most of their business in other parts of the world over primarily domestic-oriented firms.  I’d also prefer to reach into Europe through multi-nationals listed elsewhere that have some European exposure.

another week, another crisis: life in the EU

December 12, 2011 By in Current Market Thoughts, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , , , Leave a comment

background

The Maastricht Treaty (or Treaty on European Union), signed in 1992, laid down the minimum economic requirements for entering, and remaining in, the EU.  It specified, among other things, that any member country’s budget deficit should be no more than 3% of GDP and its outstanding government borrowings should be below 60% of GDP.

Members would be entitled to use the common currency, the euro–thus becoming part of the Eurozone.

One quirk of the arrangement was that the economic rules could be enforced only at the point of initially applying for membership–by denying entry to the EU to countries that didn’t qualify.  After that, there was nothing.  Why not?  No country wanted to give up sovereignty.

Italy, for reasons of bella figura, underwent an heroic restructuring of its economy so it could be among the charter members–and began backsliding almost immediately.  Greece probably never qualified for membership, but the EU overlooked its well-cooked books to advance its pan-European reach.

One other thing:  most EU members adopted the euro.  A few, notably the UK and Sweden, did not.  The latter are in the EU but not in the Eurozone.

the crisis

Trouble had been brewing for years. Even less creditworthy countries could borrow large amounts of money at favorable rates by issuing sovereign debt in euros, on the idea it would be guaranteed by the full Eurozone.  The situation reached a boiling point in 2010 when Greece announced it had been falsifying its national accounts for years.  Belatedly, lenders began to worry that the Eurozone would not stand behind all euro-denominated debt.  Worries soon expanded to include Berlusconi-led Italy.

the problem

Moral hazard.  Germany balked at stepping in to bail out Greece–and potentially Italy–without a way of enforcing the Maastricht economic criteria.  Otherwise, it risked throwing good money after bad.

where we are now

At the latest in a series of “summits,” the Eurozone countries agreed last week to amend the Treaty on European Union to give EU institutions the power to enforce the Maastricht economic criteria.  That was the final condition Germany wanted before it would be willing to stand behind Italian debt.

But…

…the UK vetoed the idea of using EU government institutions to police Eurozone member countries.  Why?  It wants concessions that will preserve its position as the premiere financial market in the EU.   (This, even though the UK’s “regulation light” philosophy nearly brought the country to its knees, gave protection to the perpetrators of the US sub-prime mortgage debacle, and resulted in sketchy ex-Soviet bloc mining companies becoming major forces on the stock exchange).

So the Eurozone countries say they’ll develop an alternative enforcement mechanism by Christmas.  But until they do, the securities markets will continue about the survival of the Eurozone.

my thoughts

It seems to me that a necessary condition for politicians to back any measure that will bring pain to their constituents is that the alternative appear worse, so that they can cast themselves as heroes for having “rescued” voters from a worse fate–even if they themselves have created the worse alternative by their inaction.  That’s just life.

The Eurozone countries are making progress, though.

Either the Eurozone will cobble together a new enforcement mechanism or–more likely, I think–it will grant some concessions to the UK in return for permission to have Brussels enforce the new Eurozone economic rules.  After all, I don’t think the UK wants to be left completely on the outside of Europe, looking in.

In any event, ratification of the new rules won’t be completed until next March.  Until then, I don’t expect to see significant Eurozone action to support the bonds issued by Italy.

My guess is that support will come, but not until Spring.

For equity investors like us, I think two factors are important:

–Europe will be in recession in 2012.  The question is only how deep it will be.  This is a time to think through how well our holdings of global companies are insulated from European demand weakness, with an eye to emphasizing those with the least EU exposure.

–it’s still too early, in my opinion, to be bottom-fishing in the EU.  There’ll be time enough for that in, say, February.