The latest euro ‘fix’ could be bad news for the US
John Stepek Sep 11, 2012
Investors are finally convinced that the eurozone can be saved.
European Central Bank boss Mario Draghi has made it clear that he’ll do ‘what it takes’ to stop the likes of Spain or Italy from going bust, as long as they ask for help.
The Germans might throw a spanner in the works later this week. But even if their constitutional court rejects or delays the existing big bail-out fund, chances are another fudge would be hastily pulled together.
So the ‘Armageddon’ discount is fading from European assets, which have rallied hard in recent months.
That sounds like good news. The trouble is, once investors stop fretting quite so much about Europe, they’ll wake up to the fact that the rest of the world is in a bit of a mess too.
And that could be bad news for overpriced shares in the US in particular…
European money-printing won’t stop a recession
The promise of money-printing from the European Central Bank (ECB) has boosted both bond prices and share prices in the most troubled parts of Europe.
That makes sense. As we saw in both the UK and the US, a bit of money-printing (or QE - ‘quantitative easing’) can work wonders for droopy asset prices.
However, if there’s another thing we should have learned about QE by now, it’s that it doesn’t have any obviously helpful impact on the wider economy.
So while I’d be happy to keep buying European shares, I don’t expect Europe itself to make a miraculous recovery from recession in the near future.
For European stocks, this doesn’t matter too much. Overall, they’ve been pricing in complete collapse. So a mere recession comes as something of a relief.
But it’s a much bigger worry for more highly priced companies. The US is a classic example. As the FT points out, US companies are more downbeat about their prospects than at any time “since the start of the financial crisis.”
Indeed, one pundit tells the paper that: “Historically, we have only seen numbers like this during times of recession.” Yet the US stock market remains near a four-year high.
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US corporate profit margins are also at record levels. That’s bad news, because it means that the only way to grow profits is to grow sales too. There aren’t any more gains to be had from ‘efficiencies’.
But if China is slowing, and Europe is in recession, the opportunities for blockbuster sales growth seem thin on the ground. In short, the US market looks vulnerable.
You’d expect investors to have taken all of this on board by now. After all, markets are meant to be forward-looking and efficient. So why haven’t they?
There are probably two main reasons. Firstly, with all the fear over Europe, just about anywhere else in the developed world has acquired a sort of ‘safe-haven’ status. US stocks have probably benefited from that.
Secondly, there’s the prospect of more QE in the US. The weak ‘non-farm payrolls’ figures on Friday cheered investors no end. They now believe that the Federal Reserve has all the excuse it needs to launch more QE this week.
But will it?
It doesn’t matter whether QE3 launches or not
The short answer is: I don’t know, and nor does anyone else. My gut feeling is that QE3 is far from being a certainty. The timing is politically awkward, and Fed chief Ben Bernanke doesn’t command the same consensus among his troops as his predecessor Alan Greenspan did.
The market is far from being in the full-blown panic mode that we saw on previous occasions when Bernanke printed. Now that the ECB is making an effort in Europe, it seems harder for Bernanke to justify more printing in the States.
On top of that, how much good would QE3 do? If investors have any sense at all, there should be a bit of scepticism creeping in about QE’s ability to do anything helpful about the non-farm payroll figures.
But as I’ve said before, it doesn’t matter one way or the other. If the US prints more money, it’ll be good for cheap assets as well as pricey US stocks. So European shares will be buoyed too. It would also be good for gold, which you should be hanging on to as portfolio insurance.
And if it doesn’t – well, better to be invested in cheap eurozone stocks than expensive US ones at that point. In the absence of QE, disappointed US investors might start to wake up to the fact that their market is looking a little pricey, particularly if Apple’s latest iPhone doesn’t impress sufficiently.
As John Dizard notes in his FT column, as fear of a euro-disaster recedes, investment strategies will change. “The relative weakness of European assets compared to those in the US will reverse over the next couple of months.” That adjustment could just as easily come through US markets falling, as through European ones rising. Subscribers to MoneyWeek magazine can read about how to gain access to European markets here. If you're not already a subscriber, get your first three copies free here.
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