Friday, November 30, 2012

Whatever Happened to the Euro Crisis?

It was hard to find a bull on European stocks six months ago.

The overwhelming consensus that the eurozone could not survive in its original format.  Greece was to be forced out of the euro, followed possibly by Spain and even Italy.

European stocks were trading at levels that reflected the widespread pessimism. Price/earnings multiples were in the single digits. The spread of dividend yields to government bonds was at 90 year wides, but there were few buyers to be found of European stocks.

Here's what I wrote last June:

There's a couple of reasons that becoming too gloomy on Europe might be the wrong approach.

The first is the fact that the situation is well-understood by all involved.  The necessary resources are available, and potential solutions available; it's just the political will that's lacking....

Think back to our own economic disaster a few years ago.  The idea of lending huge sums of money to bail out the banks - not to mention AIG, General Motors and Chrysler - was anathema to many politicians and economists.

But in most cases the bailouts worked, and most of our government's funds were repaid at a handsome profit.

Then there's the real economy of Europe.

It's hard to remember, perhaps, but first quarter GDP in the euro zone was essentially unchanged from the prior year. 

True, the growth was uneven - Germany is clearly prospering, while Greece and Spain are suffering - but fundamentally there is alot going on in Europe that is working....
I'm not denying that the euro problems are real, and the resolution will doubtlessly be difficult, but I continue to believe that the ultimate resolution will be positive.

So what's happened over the past six months?

In a conference in July, European Central Bank head Mario Draghi annouced that the ECB was willing to do "whatever it takes" to save the euro.

And there is now considerable evidence that the ECB efforts are working.

Greece is still part of the euroblock, and there is every reason to believe that it will remain a member for the foreseeable future.

Spain now appears to be in better shape than anyone would have predicted six months ago.  Here's an excerpt from a Bloomberg article this morning:

Prime Minister Mariano Rajoy continues to postpone a decision on whether to seek a bailout that would allow the ECB to buy Spanish debt. As the country’s bond yields have fallen more than 2 percentage points from a record 7.75 percent in July, the Treasury has already sold all the bonds slated for sale this year and is building a buffer for 2013. 

“If you had asked in July whether Spain would be in the situation it is now in terms of funding, you would never have bet that this would be the case, but you see what you see,” {Former ECB board member Jose-Manuel} Gonzalez-Paramo, a Spaniard who now teaches at IESE business school in Madrid, said.

European stocks have soared in recent months, producing returns that are more than double the US market, as the chart above indicates.

In short, as is so often the case, investment opportunities abound when bearish sentiment reaches a crescendo.

So what about now?  Are European stock still a buy?

I think so, although I suspect the ride will not be as meteoric as in recent months.

If nothing else, while there is no denying that the European economic picture is troubling, there are any number of quality companies that pay very attractive dividends trading on European exchanges.

Here's an excerpt from last week's Economist:

But the important thing to remember is that Europe is not an emerging market and nobody should be expecting rapid domestic growth. Plenty of European companies sell goods and services to emerging markets, however, and their prospects are thus not entirely moribund. Thinking of European equities as a source of income, rather than capital gains, puts the issue in a more helpful light.

The dividend outlook has deteriorated a bit but it is still broadly positive. According to Deutsche Bank, some 38% of listed European companies have increased dividends this year, compared with 15% that have cut payouts. The relationship has worsened since 2011 but it is still better than in 2009, when 24% of companies reduced their dividends and 13% suspended them altogether.