Europe: A contrarian perspective

With a weakening global economy European markets will no doubt test those lows. When they do, the worst place to invest might just become the best

Over the past few weeks an army of financial professionals have been frightening the markets about the potential meltdown in Europe. They tell us that the core of European bank reserves consists of toxic sovereign debt. With a meltdown imminent, the safe investments are US treasuries or German Bunds. Yet it might be time to think again. The greatest returns on investments come when fear is greatest. As Baron Rothschild said “Buy when there’s blood in the streets, even if the blood is your own.”
First as to the analysts, basically they should be ignored. According to Professor Philip Tetlock’s new book “Expert Political Judgment”, political forecasters are worse than a crude algorithm at predicting events. The more prominent the expert, the worse the predictions and there is an inverse correlation between the confidence of the individual forecaster and the accuracy of their predictions.
Problems in forecasting are not limited to the political realm. Financial experts are best only when markets are reasonably calm. They failed to predict the upside momentum of the internet boom between 1997 and 1999 and also failed to predict the depth of the crash between 2000 and 2002. They were reasonably accurate between 2003 and 2007, but of course they failed miserably in 2008. So when you need the experts most, they are not around.
The real problem is that no one can reliably forecast the future, especially the short-term outlook for economies or stock markets. Warren Buffett does not even believe that it is worth anyone’s time to do so.
But amid the uncertainty and hot air, one thing is definite. Markets do eventually return to mean. Business cycles are called cycles for a reason. Down cycles are always followed by up cycles as night follows day. It just takes time. The difference is that it may take even more time.  Governments and central banks trying to solve the problem may have made it worse. The stimulus that is supposed to be so indispensable to save the market from itself may be preventing the markets from reaching equilibrium. So instead of preventing pain, they just prolong it.
But depressions and recessions even with government help do not last forever. During a financial crisis investors have to remember one thing. The basic components of an economy don’t just evaporate. Most companies have tangible assets. Their stock may be falling like a rock, but the real estate, equipment and intellectual property is still there. Some workers may lose their jobs. Others might be underemployed, but they are still around. As investors discovered in the US, real estate loans are secured by land, which doesn’t dissipate in the morning mist. Its value is not what it was, but it does still have worth. Yes, some investors do lose money, but there is always another side to the trade. Someone’s loss can be another’s opportunity.
The Greek situation is unresolved and may remain so for many weeks. Markets do not like unresolved issues, especially political ones. This uncertainty will weigh on the markets, especially European ones. Doubt also surrounds the rising bond yields in both Spain and Italy. So it is hardly surprising that European shares have fallen 16% since the early April highs compared to 6% in the US. Money has flowed out of large stock European funds for the past 14 months. It appears that Europe is the worst place to invest, which is exactly the point.
The reality is that European equities are not totally European. American and many emerging market corporations, especially state-owned ones, earn profits mostly in their home markets. In contrast 44% of European profits come from outside Europe. European corporations earn 24% of their profits from emerging markets, almost double the amount as American corporations. So the problems in Europe will be cushioned for European corporations by their exports. The higher exports of European corporations will be helped by a plunging Euro, but this assumes that the economies of their trading partners remain strong.
Another advantage of European shares is their dividend payout. The average dividend yields for corporations in the strongest European countries, France, Netherlands and Germany is 4.1%. This compares very favourably with government bonds and the average yield for US stocks, which are only 2.2%.
Some European countries are also positioning themselves for a rebound. The recent stresses to some economies like Spain have forced their governments to make the real reforms that are necessary for sustainable growth specifically in the labour market. Germany’s present strength is due to similar reforms ten years ago.
The German market and others have not reached their lows of last September. It will take another 14%. With a weakening global economy European markets will no doubt test those lows. When they do, the worst place to invest might just become the best.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)

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