Europe Lowers Interest Rates...Time For European Stocks to Catch Up ?

The WSJ and the FT have published  with analyses of the implications of policies of "easy money"/
lower  interest rates in Europe. The WSJ notes that the policy is at least partly in response to evidence that seems to indicate the low rate policy has "worked" US economic growth is back on track and at this point the predicted inflation has not come about. Certainly the low rates have fuelled rises in the prices of financial assets with the ubiquitous "bubble" terminology in the words of many.

What are the implications for investors ? the WSJ writes

http://online.wsj.com/articles/central-banks-move-to-boost-global-growth-1416617106

Though the moves toward easier money in Europe and Asia are good for investors, they come with multiple risks. They could perpetuate or spark asset bubbles, or stoke too much inflation if taken too far. Also, they don’t address structural problems that policy makers in each economy are struggling to fix.Though the moves toward easier money in Europe and Asia are good for investors, they come with multiple risks. They could perpetuate or spark asset bubbles, or stoke too much inflation if taken too far. Also, they don’t address structural problems that policy makers in each economy are struggling to fix.

The FT writes that many analysts looking at the results of aggressive lowering of rates did to the US equity market as well as the low valuations of European stocks and see potential for a strong move upwards in European stocks.

European equities are not an obvious buy for US investors, who see their own economy forging ahead, corporate earnings beating expectations and a stronger dollar.

Yet with company earnings for the eurozone not as bad as expected, some believe the sector is now undervalued, creating pockets of opportunity in the continent....

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Analysts at Barclays believe European equities could rally “significantly” if the European Central Bank embarks on full-blown quantitative easing, which they believe is not yet priced into stocks. They predict European markets, not including the UK, will grow at the most rapid rate of any other major market next year with a total return of 18 per cent, compared twith just 5 per cent in the US and 9 per cent for global and emerging markets.

Jack Ablin, chief investment officer at BMO private bank, is optimistic QE can help the eurozone.

“QE was effective in the US and if we see the ECB act, that should be cause for optimism,” he says, estimating that developed world equities trade at a 25 per cent discount to the US market.

But, as the article notes, the dilemma for US investors is that those low rates that might push up equity prices will also likely mean a lower Euro so that for dollar based investors a good deal of the gain on equities will be lost in the adverse currency movement.

As I noted in a previous article even individual investors have a vehicle  ETF HEDJ which lets them hold European stocks but hedge the currency risk. Apparently investors are incrreasingly looking at this instrument

The most popular exchange traded funds this year include the WisdomTree Europe Hedged Equity, which saw some of its largest daily net inflows in November, according to data from ETF.com.

And even without the currency hedge: 

Some believe European equities have further to rise than the euro has to fall, making them still worth buying even without a hedge. A rule of thumb investors use is that a 10 per cent fall in the euro against the dollar boosts earnings per share for European companies by 10 per cent.

One should of course be cautious about drawing too many conclusions from short term data it is often the case that the moves immediately after major economic events point a way towards long term movements.They often mark inflection points. This may be the case with regard to Europe. The weaker Euro trend continues. European stocks have rebounded quite a bit since October and accelerated more since the ECBs November 21st announcement of a bond buying program but still significantly lag US stocks.

Here are some one year charts

Unhedged Eurozone ETF FEZ

Currency Hedged Euro ETF  HEDJ

Germany (EWG) unhedged

And the Euro/US $ Exchange Rate