Tag Archives: Europe

thinking out loud about Euroland (II)

November 14, 2011 By in Constructing a Portfolio, Current Market Thoughts, Foreign markets, Portfolio management, Strategy Tags: , , , , , , , , , , , , , Leave a comment

Euroland is small

Yesterday, I tried to argue that in world economic terms the Eurozone is smaller than many investors believe and that, therefore, even a severe recession there next year will only have a mild negative impact on global growth prospects.

There are two additional economic factors to consider–trade and investor expectations.

trade

Ex oil, most trade among Eurozone members is with each other.  Sales to the EU from China–Europe’s largest external trading partner–amount to less than 3% of the economy of either.  The same is true for business between the US and the EU.

Trade usually rises and falls faster than a country’s overall economy, though.  So a 5% decline in Eurozone GDP next year might translate into a 10% decline in imports.  Certainly not a good thing, but not by itself a disaster, either.

investor uncertainty

To my mind, the bigger issue by far is investor uncertainty.  Such fears typically turn out to be wildly overstated.  That knowledge doesn’t help much, however, if it’s your portfolio that’s being swamped by waves of irrational selling.

Even though Americans have been investing in foreign stock markets in a serious way for almost thirty years, I think most people still don’t understand that there isn’t a one-to-one relationship between world economies and world stock markets.  The relationship works for bonds, which comprise a much larger class of securities, but not for equities.

There are two reasons for this:

–in most countries, large portions of the economy have no publicly listed companies.  In the US, for example, the real estate, housing and auto sectors, all of which are important for GDP growth, have very little stock market representation

–in many countries, the owner of a domestic enterprise can easily be a foreign company.   In this case, the owner’s main public listing is probably in a foreign country–if it is listed at all.  Again, it contributes to GDP but has no local stock market presence.   TIF, for instance, is a US company but earns money and adds to GDP in the EU, Japan and China.  Ikea is a global furniture company founded by a Swedish entrepreneur.  It’s incorporated in the Netherlands and not publicly traded anywhere.

world stock markets by size

In world stock market terms, the Eurozone is smaller than it is in a macroeconomic sense.

The world stock markets open to foreigners break out roughly as follows:

US          45%

Eurozone          11%

rest of Europe (mostly the UK, with a dash of Switzerland and Sweden)          13%

Japan          9%

Canada + Australia          8%

emerging markets          14%.

Slicing the Eurozone up a bit further, the area’s main components are Germany and France, which together make up more than half the total.   By far the biggest sector is financials.

Unfortunately, there’s no reliable information I’m aware of to sort out the relationship between where companies in continental Europe may be listed vs. the countries where they make their money.  I think we should assume that all financials are pan-European enterprises, no matter where they are listed.  For other sectors, the tendency has been for countries to declare that certain companies or industries are national treasures and can’t be acquired by foreigners.  My guess–and it really is a guess–is that ex financials, most multinational exposure is to non-Eurozone areas.  If so, this exposure would be an economic and stock market plus.

conclusions

In the parsing of world stock market above, which gets down to the level of markets that make up as little as 2% of the world’s stock markets, Greece, Italy, Portugal and Spain don’t show up at all. They’re that small.

In terms of investor concern that’s depressing overall European markets, then, the issue has got to be either the indirect effects on business in France and Germany of problems in smaller Eurozone economies and/or the negative effects on the very large banking sector.  My guess is that the negative signal European markets are giving is much more the latter than the former.

 

Tomorrow–how to structure an equity portfolio in light of European stock market weakness.

more on “discounting”

September 25, 2011 By in Current Market Thoughts, Discounting, Portfolio management, Recent Market Action, Strategy, Technical Analysis, Trading Tags: , , , , , , , , , , , , , Leave a comment

discounting

“Discounting” is the jargon that Wall Street uses to describe the process of factoring changes in consensus beliefs about future happenings into today’s stock prices.  I’ve outlined the basics of discounting in an earlier post.

fundamental vs. technical analysis

Fundamental analysis, the study of company-specific and economy-wide economic and financial information, and technical analysis, the study of charts, can be seen as two approaches to discounting.  In the first case, researchers try to figure out what information is most important for making a security’s price go up or down, and then actively search for relevant data.  In the second, investors study chart patterns as a way of figuring out what fundamental analysts are doing and then riding on their coattails.

the internet

The internet has changed the amount, quality and cost of information in dramatic fashion. For example:

–When I was building an international equity investing organization for a major financial institution in the early 1990s, it cost about $300,000 a year in today’s dollars to get access to all corporate SEC filings.  The data came on microfiche and was available about six weeks after the documents were filed.  Today, the information is free on the SEC’s Edgar website; documents are available the instant they’re filed (companies do this electronically).

–Thanks to regulation FD (Fair Disclosure), company presentations are routinely webcast and are available through the company website.  Typically, they’re archived for at least a year.  True, breakout sessions at conferences, small group meetings or one-on-ones aren’t, but these mostly serve to fill in the blanks for analysts not familiar with a firm.  Companies may sound like they’re revealing new information, but they’re not.

–A Bloomberg terminal still costs $30,000-$50,000 a year, depending on its capabilities.  But discount brokers offer most of what an individual investor needs to their customers on their websites for free.

discounting and Greece

Discounting isn’t a one-time event.  It’s a process.

1.  For one thing, what’s painfully obvious to a seasoned observer or an industry specialist may only dawn on the average investor a considerable time later.

2.  Also, bad news that relates to a specific event is typically not fully discounted until the event occurs–no matter how far in the future that may be.  The financial crisis in Greece is a good example.

A year ago, a new administration in Athens revealed that the country had been falsifying its national accounts for many years.  Greece had taken in less in taxes and also spent a lot more than it had ever revealed.  How so?  Its membership in the EU had allowed it to borrow much more than it could ever repay.

For at least six months, it has been clear that either the rest of the EU will be forced to pick up the tab and let Greece remain in the EU, or that Greece will default and lose its EU membership.  In default, holders of Greek sovereign debt would lose most of their money.  But, since that’s mostly big EU banks which might need government bailouts as a result, the effect is basically the same.  EU taxpayers ultimately foot the bill.

Over recent months, however, EU stock markets–and the financials, in particular–have been subject to periodic waves of selling, driving prices ever lower, as investors express their fears about Greece.  …despite the fact that in general terms everyone has already read the closing chapter of the story.

This pattern of discounting the same news over and over again is typical.  It begins in denial (inadequate discounting) and may end in despair (overdiscounting), the same emotional pattern that shapes a bear market.  While bear markets end in a whimper sometimes, however, discounting that anticipates a discrete event usually involves a final selling bout as the event actually occurs.

Over the weekend, the G-20 seems to have given the EU an ultimatum to resolve the Greek crisis quickly.  We’ll see tomorrow how the markets react.

BIS: a currency collapse is a good sign, not a bad one

June 14, 2010 By in Basic Concepts, currency effects, Current Market Thoughts, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , , , , , , , , 1 Comment

In its latest quarterly review, published this morning, the Bank for International Settlements (the organization that comes up with international bank capital adequacy rules) presents results of research into currency collapses that is of particular importance to stock market investors.

the bottom line

The research studies a large number (79) of past currency collapses, mostly in developing countries.  There’s a complicated definition of what constitutes a collapse, but it’s basically meant a drop of 22% or more in the value of a country’s currency in a short period of time.

Collapses are associated with a permanent loss in real GDP of 6%–not a good thing.  –also something you’d expect to see.

What’s interesting about the study, though, is that it finds the output loss begins three years before the currency drop.  Therefore, although the currency decline is correlated with the output loss, the currency movement doesn’t cause it.

In fact, quite the opposite.  The currency collapse appears to mark the beginning of a period of accelerating economic growth that would likely not have occurred in the absence of the currency decline.  The better economic performance continues for several years, and ends up offsetting about two-thirds of the economic loss.

In other words, the currency decline, although frightening, is the first sign of economic healing, not the harbinger of further economic doom.  (Note, again, there’s no claim to have established causation.  The only assertion is that the better economic performance comes after the currency debacle.)

think:  the euro

The fall in the euro vs. the US dollar has been 21%+ over the past half year or so.  For my money, this counts as a currency collapse.

We know in theory that currency decline has three effects:

–it acts like a drop in interest rates as a stimulus to economic growth,

–it redistributes economic energy toward exporters and import-competing industries.  It channels growth away from importers and foreign manufacturers.  And,

–it increases the value to locals of foreign hard-currency assets.

Said a different way, a stock market investor should look for companies that have hard-currency revenues and weak-currency costs.

My experience with European stocks has been that recognition of the new currency facts of life lag the actual currency movements by a couple of months.

What does the BIS study add to these theoretical musings?  The fact that in 79 past instances, this is the way things have turned out.

the euro decline: how will it affect US stocks? does hedging help?

June 2, 2010 By in Accounting, currency effects, Current Market Thoughts, Recent Market Action, Stock ideas Tags: , , , , , , , , , , , , , 2 Comments

the euro decline

Since early January, the euro has dropped against the dollar by about 15%, from 1€=$1.45 to 1€=$1.22. How will this affect the earnings, and consequently the price performance, of US multinationals that have substantial operations in Europe, like pharmaceuticals, or food, beverage and personal products companies?

negative effects?

My answer is:

–it depends;

–the effect is negative, but it will vary in importance by industry–meaning by how much of a firm’s European costs are denominated in dollars, what discounting it can get from its suppliers and whether it can substitute euro-denominated cost items;

–in my experience, investors tend to make a relatively large positive response to earnings gains that seem to come from being in a rising-currency country and to more or less shrug off losses that come from being in a declining-currency country.   The only exception I can think of to this “rule” is  Japanese electronics companies.  The market in Tokyo seems to regard these firms as commodity producers with indifferent management, therefore a relatively pure play on currency movements.

the much BIGGER story

My conclusion from all of this is that the big investing story–which I think is already beginning to unfold in price movements–is the attractiveness to European investors (and thus for everyone else in the world) of multinationals based there that have dollar exposure.

a footnote

There are two types of currency effects that appear in the financials of multinationals.

–One is the operational positive (negative) of having hard-currency revenues (costs) and weak-currency costs (revenues).

–The other is translation effects.   In my experience, investors everywhere ignore these.  (In simple terms, they come principally from converting foreign-currency balance sheets into the home currency at the end of an accounting period.  A US company, for example, would show a translation gain in the present circumstances from the loss in dollar value of its euro-denominated debt, offset by translation losses in the value of its euro-denominated assets.)

what about hedging?

Most larger companies hedge a least a portion of their anticipated foreign currency exposure.  In the case of exporters with long gaps between the time when they take/price an order and when they make delivery/collect their money– especially if the price is denominated in a foreign currency, —hedging can be crucial.

The purpose of hedging is to increase the probability of obtaining a satisfactory profit from operations.  It’s not to secure the highest possible profit.  So it’s reasonable to assume that hedging operations temper the size of any gains due to currency movements on the way up, as well as cushion any losses on the way down.

If a company faces a permanent depreciation of the currency in one of its export markets, I think that the fact it may have hedged against this for the next six months is irrelevant to the stock’s price.  Investors will understand that, although the company has done a good thing, it has only postponed the depreciation-induced hit to earnings–not eliminated it.  The stock will trade on anticipated post-depreciation results.

Porsche was an interesting case along these lines about seven or eight years ago.  The company, which produced its luxury cars exclusively in Europe, hedged three years’ worth of anticipated sales in dollar markets to offset what it (correctly) viewed would be   a prolonged period of euro strength.  Let’s say the appreciation in value of its hedging contracts made up a third of the company’s earnings over this period.  How do you value this portion of company profits.  My view, and that of virtually all American investors, is that hedging profits should be awarded a much lower multiple than the manufacturing operations’ results.  Europeans–and they were the dominant force in their home market–by and large thought the opposite.  Crazy, but true.

Another issue in dealing with hedging income is that most companies seem to me only to talk about the topic when things have gone badly wrong.   The cynic in me thinks that companies understand that hedging earnings aren’t highly valued, so they remain mum.  Among American companies, MCD is unusual in having said that it has hedged its anticipated profits from Euroland for all of 2010 at a rate of $1.41.

So:  1. investors, especially in the US, don’t care much about hedging, and 2. even if they did, many firms don’t disclose enough data to make the task worthwhile.