How to Position Yourself Amid European Turmoil.
According to the databases, the S&P500 just experienced its worst May performance since 1962 while the Dow had its worst May since 1940 and we have Greece, Spain and the rest of the EU to thank for it. Savvy and nimble investors, of course, were able to avoid much of the pain by moving assets to markets less sensitive to the economies of those Sovereign entities, right? Think again. Here’s a little quiz: Now don’t glance at the chart below until you’ve finished reading! In which market would you rather have been invested during the recent ruckus over a potential European debt crisis? 1. The Shanghai Composite—China has the best balance sheet of the developed nations with plenty of reserves and no sovereign debt, however, the EU represents over 20% of Chinese exports. 2. The French CAC-40, which is comprised of companies deriving their earnings principally from the EU, including French banks that would have to write down their book values by over 40% in the event of a Greek and Spanish default. France also admitted at month-end that it would be a challenge to maintain its own AAA debt rating. 3. The S&P500, comprised of multinational corporations receiving only about 10% of their total earnings from the EU. 4. The NASDAQ Composite, made up of high-growth technology and biotech companies earning less than 5% from the EU in total. 5. The US Russell 2000 Index of small cap stocks, which are principally domestic-focused. 6, The German Xetra DAX—Germany is the EU country which will be shouldering most of the burden of pulling its fellow members out of the fire. 7. The Spanish IBEX—need we explain this one? 8. The UK FTSE 100—UK exports to the EU account for about 29% of GDP and the UK Pound has appreciated versus the Euro.
OK, now you can examine the chart below.
The answer, other than the obvious fact that you would have wanted to avoid the Spanish stock market, is that it almost didn’t matter in which developed, Eurozone-affected equity market you invested your money last month—you would have lost a similar amount of money in any of them. The conundrum, however, is that the equity market of one of the most vulnerable countries to a PIGS debacle, France, outperformed almost all of the equity markets in May while stocks in China, with the strongest economy, no debt and the reserves to stimulate, underperformed all but Spain. The FTSE, in a worse position than the US vis-à-vis currency and trade with the EU, outperformed the US. What’s going on? As we see it, there are several countervailing forces at work. First, US hedge fund managers, remembering the debacle of 2008, chose to shoot first and ask questions later—and they tend to be invested more heavily in mid-cap and technology stocks as found in the NASDAQ, the big domestic loser. Secondly, less trigger-happy investors began focusing on the markets where the weaker Euro would be a benefit—the European countries with the largest components of exports in their GDP—and where it would be a detriment—e.g. the US and Chinese multinationals. That’s the reason Germany, with over twice the exports of France, has seen the DAX dramatically outperform the CAC-40 this year and all US and Asian markets last month. Thirdly, the Chinese market is reacting not only to efforts to reign in the property bubble but to the strengthening of its currency versus the Euro, a double-whammy of anxiety. Finally, for the conspiracy-minded, there is the headline timing issue: for the latter part of the month, encouraging comments by politicians tended to come out during the trading day of European bourses (purposefully), allowing them to close higher, while the bad news was saved for “after market hours” (again purposefully) while the US equity markets were still open, sending them lower.. Do that a couple of days in a row (which occurred) and it certainly offers one explanation why the S&P 500 couldn’t put together two back-to-back positive days the entire month while the Euro bourses could. .Fitch’s Friday downgrade of Spanish debt just after the European markets closed but while the US markets were still trading, is a prime example of this.
What to make of this all? Of course this data is all backward-looking but it can give us a clue as to how some markets will perform for the rest of the year. First, we agree with the view that the export-minded EU countries are a buy right now. Several major investment banks have upgraded growth expectations for the stronger, export driven European economies over the past month as did the OECD last week. Secondly, we believe that the sell-off in smaller, US-focused countries is way overdone and that, going forward, they will outperform the large, US multinationals with significant European/currency exposure, especially if the Federal Reserve keeps a rate hike on extended hold, which we think will happen. The stronger dollar will continue to lure overseas investors to our markets and while some of that money will find its way into Treasuries is will also go into perceived “Euro-free” stocks, favoring small caps. Finally, though we have been dead wrong on the Chinese market this year, we have been correct on their economy and we believe that the Central Government will reverse their tightening course as soon as the measures appear to be working (which, as of this morning, they seem to be), especially in light of current world weakness, making Chinese stocks worth a serious look now, after a 20% slide year to date.
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