Thursday, February 28, 2013

Another Buying Opportunity in European Stocks?

Early last summer, when bearish sentiment on the euro was at its peak, European stocks were trading at incredibly cheap levels.

No one wanted a piece of some of the world-class companies that could be found in Europe, regardless of the fact that P/E multiples were mostly in the single digits and dividend yields in some cases were 3x as much as sovereign government bonds.

All that changed, of course, in late July when European Central Bank (ECB) head Mario Draghi declared the ECB would do "whatever it takes" to save the euro.  European stocks began to rally, and by the time 2012 ended the major European indices had climbed by more than +20% from late July lows.

Earlier this week, Italians voted their displeasure with the austerity measures of current Prime Minister Monti.

In what was widely seen as a protest vote, former Prime Minister Silvio Berlusconi  and populist comedian Beppe Grillo received large dollops of the popular vote, and at this writing the actual composition of the new Italian government is very much in doubt.

The international financial community was largely been stunned by the Italian election results, since incumbent Monti was seen as the voice of fiscal reason.  Austerity is never popular, particularly when it is administered by a leader whom the Italians viewed as merely doing the bidding of the Germans.

Spain, too, has experienced its difficulties since the beginning of the year. Several large bankruptcies occurred in January due to the -40% decline in housing values in Spain since 2007. The trembles in the Spanish system  raised once again questions not only about the state of the Spanish banks, but also the creditworthiness of billions of Spanish debts held by banks throughout Europe.

So, with all of this as a backdrop, do we once again have the opportunity to buy Europe on the cheap?

In my opinion:  not yet, although I still believe that a longer term investment in European equities will reap handsome rewards for investors.

Unlike last summer, when both the bond and stock markets showed the intense investor anxiety over the state of the euro, most of the market reaction seems to be fairly mild.

Here's James Mackintosh writing in Wednesday's Financial Times:

Italy's bonds have only had a worse day once since the euro began, and the country's chaotic politics was responsible then too.  Back in November 2011, the market took fright when prime minister Silvo Berlusconi delayed his resignation.  This time, the market was afeared because Mr. Berlusconi, along with populist comedian Beppe Grillo, did so well in the inconclusive elections.

The 40 bp jump in the 10-year bond yield looks appalling.  Yet, it only rose to 4.9 per cent.  This looks terrible compared with safe Germany, at 1.45 per cent, or even Colombia, paying 3.3 per cent on its dollar bonds.  But Italy was at these levels just three months ago.  All that has happened is the weeding out of the excessive optimists who bought this year.

The relatively sanguine mood of investors was also captured in the remarks by some of the speakers at a private equity conference in Berlin taking place this week.

Here, for example, were the comments of David Rubenstein of the Carlyle Group* as reported in Wednesday's New York Times:

David M. Rubenstein remains bullish on Europe.

Speaking at an industry conference here, Mr. Rubenstein, the co-founder of the Carlyle Group, said European companies were now more open to selling distressed assets, and that sales related to bank bailouts by local governments could provide one of the best opportunities.

“Whenever you can buy assets from a government entity in Europe, you should do it,” Mr. Rubenstein told attendees at the SuperReturn private equity conference on Wednesday. “You will see distressed sellers sell assets at judicious prices.”

His comments echoed remarks he made at last year’s conference, when he described Europe as “one of the world’s greatest investment opportunities” because “there’s no part of the world that will see so much assets sold at a discount as in Europe.”

My impression is that most market participants are much calmer than last year simply because there is so much evidence that the European community is totally committed to preserving the euro block.

*full disclosure:  the Carlyle Group is a major shareholder of Boston Private Financial Holdings, which is the holding company for my employer.