The details are as changeable as the euro-dollar exchange rate. Despite the announcement of a euro 100 billion bailout for Spanish banks last weekend, Spanish bond yields soared to new heights, a sign of worsening trouble.
This week, the Euro zone’s problems are expected to be a focus of the G-20 meeting in Mexico.
But if there’s one constant, it’s that Europe has been in a long-running crisis. And with great consistency, many investors have responded to this dismal drumroll by pulling their money out of European stock markets in search of safer assets, or those that seem so, with United States Treasuries near the top of the list.
That’s why the latest advice from Litman Gregory Asset Management, a financial services firm based in Orinda, California, is so startling: it may actually be time to start increasing investments in Europe.
“We think the markets have gotten ahead of themselves,” said Jeremy DeGroot, the chief investment officer at Litman Gregory, in a telephone conversation last week. “They’ve priced in so many problems for Europe that, on a relative basis, European stocks look very attractive for long-term investors.”
“Relative” and “long-term” are the operative words here. Despite Litman Gregory’s contrarian approach, DeGroot makes it clear he isn’t sanguine about Europe’s immediate prospects. “I don’t think we have a more optimistic view on that than the market consensus,” he said.
In his view, neither the bailout of Spanish banks nor the Greek election is likely to resolve the problems of the Euro zone. In the weeks ahead, he adds, volatility is quite likely to flare up again. And so we may well see a resumption of the flight to safety that has battered global equity markets and brought Treasury yields to extraordinarily low levels. Furthermore, in a period of weakness for Europe, the euro could well weaken further against the dollar, elevating the risk for investors in foreign stocks.
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“We’re really not very bullish on Europe for the short term,” DeGroot said, adding he was emphatically not urging investors to take a quick, deep plunge into the market in the hope of immediate gains.
But despite those caveats, he does see a compelling case for investors with at least a five-year time horizon to raise their exposure to European equities.
In a model portfolio for American mutual fund investors with a middle-of-the-road approach to risk — a “balanced” portfolio with 60 percent of assets typically allocated to stocks and 40 percent to fixed-income holdings — the firm suggests increasing exposure to European and other foreign stocks by a modest six percentage points. That would include two percentage points allocated specifically to an exchange-traded fund devoted entirely to Europe. And it would reduce investments in investment-grade and emerging-market bonds and in large-capitalisation US stocks by an equivalent six points.
The firm expects emerging-market economies to grow faster than those in developed countries, so it advocates increasing emerging-market investments, DeGroot said. But the main reason for ratcheting European exposure upward is less about Europe’s potential than its prices: its stocks have become more attractive precisely because they have been beaten down so badly.
“The uncertainty stemming from Europe has led its equity markets to cheapen relative to the US equity market to the extent that we believe Europe now presents an attractive tactical opportunity,” the firm said in a note to subscribers of its No-Load Fund Analyst newsletter.
Over the last 12 months, for example, the CAC 40 stock index in France lost more than 24 percent, dividends included, when converted into dollars, while the IBEX, which tracks Spanish stocks, lost more than 36 per cent, according to Bloomberg data. That compared with a total return of 8.5 per cent for the Standard & Poor’s 500.
Principally because of the lowered prices in Europe, Litman Gregory projects that the overall European stock market is likely to have a “low double-digit return,” annualised, over the next five years, compared with a five per cent return in the United States stock market. These are only rough estimates, of course, and, given the downturns in recent years, they may seem overly optimistic.
“We don’t want to give the impression of false precision,” DeGroot says. But he says the data certainly suggests that, relatively speaking, the overall European stock market is now cheaper than that of the United States.
This is actually a widely held view, according to a BofA Merrill Lynch Global Research survey, conducted from May 31 to June 7 and involving 260 fund managers. Europe is the most undervalued region in the world, managers said in that survey — but the question is what should be done about it. With the European crisis still very much unresolved, these managers have generally been shunning the euro zone’s stock markets, a move that may have shielded them from even greater losses.
DeGroot on the other hand, says he sees the values offered by European stock markets as a “fat pitch” — although he isn’t taking a very big swing at it right now because “the short-term risk remains rather high.” If conditions in Europe settle down, the firm is likely to recommend higher allocations.
But if you’re concerned primarily about the next six months, and you’re not willing to risk losing much capital, plunging deeply into European stocks may be the last thing you want to do.
That, of course, is the challenge of contrarian investing. The idea is to buy when the market is low, and to sell when it’s high — a feat that requires excellent timing and strong convictions.
Increasing exposure to Europe substantially in the middle of a crisis may not seem appealing. But it may be wise to start dipping your toe into the water.
© 2012 The New York Times News Service