The disconnect between Wall Street and Main Street is often difficult to grasp. Whereas investors in U.S. financial assets have been reaping generous rewards, most Americans, in comparison, were faced with a far more moderate, if not underwhelming outcome related to the nation’s economic recovery. It should not come as a surprise that this particular relationship will have to rebalance, likely in the direction of a more robust economy with less attractive investment returns. The reverse logic, however, holds true given current conditions in most of Europe, most notably considering the nations bound by its monetary union (EMU); i.e., in 2015, we may see the resurfacing of Euroland’s attractive investment opportunities, despite deteriorating economic conditions.
The philosophical angle in favor of my argument is obvious: European policymakers and politicians have simply not done enough, and the right “mix” of restructuring, redistribution, and monetization has to be determined. Mario Draghi, head of Europe’s Central Bank, has clearly arrived at a crossroads, and the application of accommodative policies will either make or break him in the very near future. The divergence among European Central Bankers has become very apparent; the ECB’s press room offers an eerily entertaining perspective, allowing insights into opinions of the bank’s board members, which could not be more different in their objectives--especially Draghi vs. his German counterparts. Persistent gridlock and a failing economy will do the rest. Mr. Draghi will have no choice but to move policymaking to an “American-style” framework.
The investment angle across the pond is more of the same as experienced over the past years, but with a few new twists anchored in seemingly attractive valuations, a declining euro, and favorable technical conditions:
- European stocks have not only underperformed U.S. names, but now offer attractive perks in comparison to domestic markets, which are no longer cheap. Dividend yields, depending on country selection, range generally between three and four percent, almost double the income received when collecting dividends in domestic stocks. In addition, European price-to-book values are only half of what U.S. investors are willing to pay at home.
- Although the euro has declined sharply, it should not become a foregone conclusion that additional weakness is the path of least resistance, as many of the anticipated accommodative policies may be “priced-in.” Every upside surprise to current economic conditions will likely boost returns of euro-denominated assets, magnified by potential currency gains.
- The technical picture is mixed, but neutral overall, likely reflecting the caution of investors in allocating to European markets. The EuroStoxx 50 has been trading above a strong support level dating back to 2011, the date of the last European crisis. But when analyzing data going back to 1987, relative strength of European markets vs. U.S. stocks is at an all-time low, and a mean reversion will likely have to take place at some point.
A more aggressive ECB policy stance will signal relief to the global marketplace, and possibly remove barriers of a seemingly too-narrow approach benefiting only a few EMU member countries. Whereas outright QE remains a debate, the ECB could even (or instead) act as a buyer of European stocks, which would not be an entirely far-fetched concept, considering that global central banks have increasingly acted in this capacity. Nevertheless, should Draghi and/or one of the member countries fail altogether (as recently discussed regarding the “Grexit”), the fallout could even be considered a bullish signal, either in formation of a stronger core Europe or “clearance” of policy gridlock. As long as central banks inject liquidity into the global financial system, investors are better off owning real assets, including high-quality companies. A European equity allocation may offer good risk/reward, in this respect.
Matthias Paul Kuhlmey is a Partner and Head of Global Investment Solutions (GIS) at HighTower Advisors. He serves as wealth manager to High Net Worth and Ultra-High Net Worth Individuals, Family Offices, and Institutions.
