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European Stock Selloff: Noise and Opportunity…or Signal of Worse Times Ahead
European stocks have
fallen sharply over the past month. Based on ETFs total returns between June 20
and July 22 the selloff looks like this:
FEZ (Eurozone) -4.5%
EWG (Germany) -3.7%
EWI (Italy) -6.1%
EWP (Spain) -5.3
Over the same period
the S+P 500 is up 1.2%
When looking at short
term moves of this magnitude it is useful to review the fundamentals and to
judge whether a move of this type is “noise” a movement based on short term
news but not something that changes the long term picture or a major signal.
Markets overshoot and in my view it isn’t often that a large move like this is
justified by fundamentals.
Sections in italics are quotations from the article
Germany was the first
of the European stock markets to recover from the Euro crisis of 2011. German
stocks sold off along with the rest of the Euro zone during the crisis despite the fact that the
largest German companies are world class multinationals( Siemens, BASF, Daimler
Benz for example) and not dependent on the Euro zone for their success. The
valuation discount of these stocks vs US competitors created an opportunity for
investors and the German market recovered as price returned to value.
As Bloomberg notes:
The DAX (German Stock
Index)rallied as investors sought safer stocks during the euro area’s
sovereign-debt crisis and bet that Germany’s export-oriented companies
would benefit from global growth. While the index surged more than 25 percent in each of the
past two years, it’s gained only 1.9 percent in 2014, lagging behind the 10
percent jump for Italy’s FTSE MIB Index and the 7.4 percent increase in
Spain’s IBEX 35 Index. (IBEX) The Stoxx Europe 600 Index has climbed
4.3 percent this year.
Not surprising there has been a bit of
performance chasing as seen in ETF flows:
Traders have pulled almost
$817 million in the past six weeks from a U.S. exchange-traded fund holding
German companies, while investing $270 million in an ETF of broader European
equities, according to data compiled by Bloomberg…. The number of shares
outstanding on the Vanguard
FTSE Europe ETF (VGK) climbed to arecord 289
million this month, while it fell to 161 million for the iShares MSCI Germany
ETF, the least in more than a year, data compiled by Bloomberg show. Traders
have pulled almost $1.2
billion from the German fund in 2014, after
investing in it for the past five years, according to the data. They’ve added
or kept money in the European ETF every week but two since April 2013
There is some logic to
investors spreading their assets beyond Germany and elsewhere in Europe. The
valuations are more compelling in Italy and Spain and the data particularly
from Spain are more encouraging. Both the Italian and Spanish indices include
world class multinationals not dependent solely on domestic markets. There is
one crucial difference: financials have a significant weighting in the Italian
and Spanish indices and there are concerns about financial stability.
Nonetheless the aggressive low interest rate and other policies of the European
Central Bank (ECB) stands behind those financial institutions.
As the Bloomberg
Even after this year’s advance, the Spanish equity gauge
percent away from its 2007 peak, while the
Italian measure and Portugal’s PSI 20 Index (PSI20) would
each have to more than double to recover their highs of that year. Greece’s
ASE Index would have to more than quadruple to match its 2007 top.
American investors are willing to gamble on riskier assets in
the euro region as they seek better valuations outside their home markets and
expect the European Central Bank to
continue supporting the economy, according to Raiffeisen Capital Management’s
The ECB introduced a
negative deposit rate in June as it announced new long-term refinancing
operations and said officials will start work on an asset-purchase plan.
President Mario Draghialso
indicated the central bank’s willingness to do more if necessary.
positives for earnings growth seem in place and German and other European
stocks are still at a valuation discount to the US:
At the same time, analysts estimate earnings growth for U.S.
companies will be smaller than for European ones. Profit will climb 11
percent for those on the S&P
500 in 2015, compared with a 14 percent gain
for the DAX, according to the average projection compiled by Bloomberg. Those
listed on the PSI 20 will see a 43
percent jump in earnings next year, while they
will rise 21 percent for the IBEX 35 and 25 percent for the FTSE MIB, the data
Against the backdrop
of positive fundamentals for Europe what explains the large one month selloff?
The major explanation
is the heightened tensions between Russia and the Ukraine. Germany has the
largest trade relations among European countries with Russia and the Ukraine.
This has been the apparent reason for the weak performance of German stocks
over all of 2014 but it has been even more pronounced recently. In fact in the 3 days since the downing of the
airliner over the Ukraine the DAX German index fell 2.5%.
A bit earlier in July
the prospect of a renewed European debt crisis spooked investors for a brief
period due to fears about the financial status of Portugal’s Espirito Santo Financial Group SA. Was it noise? As of the the market close in the US on July 24 both the Italy(EWI) is 3.8% above its recent low closes on July 17.. Spain(EWP)is 3.6% above its low on that date
As seen from the
one year charts below for EWI (Italy) EWP (Spain) EWG (Germany) and FEZ (Euro
zone) all are still significantly below their recent highs.I have added the 200
day moving average to the charts. This is a widely used indicator as a buy sell
signal. Those interested in a discussion of the use of moving averages as a
meand of trend following/capturing the momentum factor might be interested in
looking at the work of Mebane Faber here