John Manley, CFA, Chief Equity Strategist
All I know is what I read in the newspapers, see on TV, hear on the radio, gather from the internet, and learn from my associates. Everything else pretty much eludes me until it pops up in one of my regular sources.
In recent weeks, the stories that I have read, seen, heard, and gathered about Europe have not been good. Most tell tales of sluggish sales, high unemployment, stifled demand, and spreading weakness.
Much of this is self-induced. Many of the peripheral nations in Europe had run massive deficits for years and now are being forced by their larger, more solvent brethren (the ones with the euros to lend) to adopt fiscal austerity (even in the face of economic weakness) to ultimately lower their structural deficits to more manageable levels.
I believe that the intolerance of the capital markets, especially the equity market, has forced this issue out of the future and into the present tense. I have read, and so I believe, that Germany, Europe’s largest, strongest, and most populous economy, has been the most strident advocate of these policies. Since they have the geld, I guess they make the rules.
But now I read that the economic weakness is spreading across the continent. Germany itself seems to be on the verge of a recession. It appears that, when Mrs. Merkel’s party goes to the voters in October, it could be facing an electorate in a recession of its own making.
When I have had enough of words, I switch to pictures and look at stock charts. Strangely, when I look at the price-performance graphs of the various European markets, they seem to deny the dire predictions I have read.
The German DAX has risen almost 10% in the last month and surpassed its interim high of 2011. It is less than 10% from its all-time high. In London, the FTSE has risen only 7% in the last month but it is at a nine-month high. In Paris, the CAC 40 has risen over 9% in a month and now is at its highest level since mid-2011. The Milan Borsa gained 9% in late November and early December, fell sharply on the announcement of the impending resignation of Prime Minister Monti, and then gained back more than 5% in the last week. In Spain, while the IBEX is down 6% in 2012, it is up more than 30% off its summer lows.
This is not how markets are supposed to trade when their underlying economies are either in or going into recessions. Maybe it is a function of already low valuations and expectations. Maybe it is a liquidity rush from the European Central Bank or that institution’s calming presence in the sovereign debt market. Or, as Brian Jacobsen has mentioned, when the results of austerity become severe, perhaps it is time for the austerity to become less austere.
In any case, I believe that we have an opportunity to let the markets predict the fundamentals, instead of the other way around. The equity markets of Europe have been rising when predictive fundamentals said that they should fall. I think I have more faith in the markets.
As a postscript, I have attached a chart of the price-to-earnings ratio of the information technology sector vs. the S&P 500. The reader will note that it has moved to a slight discount to the market. I believe that no small part of that valuation contraction was due to weakness in Europe experienced by the large capitalization multi-national tech companies. I suspect a better Europe could be a positive for a historically cheap sector.
Past performance is no guarantee of future results.
The views expressed are as of 12-17-12 and are those of Chief Equity Strategist John Manley, CFA, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.