Ask any of my co-workers and they’ll tell you that I’ve been the biggest cheerleader for investing in Europe since 2012 and while It’s been nearly two weeks since the last post devoted to Europe; I slook at yesterday’s big move in European-oriented ETF’s as a lot of energy expended on Mr. “Say Anything” Draghi and an investor sentiment survey. Having some capital to put to work, I’m very tempted to load up on some Eurostock exposure, but instead I’m going to pull a Costanza and not do anything. It’s very easy to get caught in the excitement over the sector starting to show signs of life, now is precisely the time when it pays to take a step back and instead of selling my mint-condition G.I. U.S.S. Flagg carrier so I can buy more EZU I need to decide what my targets should be and what I expect for this position.I know, totally Debbie Downer. But I’ve fallen in love with Europe before and been burned, so this time, we’re going to have some ground rules baby.
- Momentum is improving: Both on an absolute basis compared to its recent history as well as versus the S&P 500, Euro stock sentiment is heading in the right direction. Looking strictly at EZU’s history, two weeks ago the ETF was literally at rock bottom. Both the short and long term rankings were so low they didn’t deserve a percentile score and worst yet; it had been that way for some time. Momentum, like volatility, tends to persist so winners will continue winning and losers losing until the trend changes. When you’re winning, low rankings tend to be followed by positive performance over a certain time frame, in the case of EZU, it was followed by more losses. But there may have been a trend change and momentum scores are just to the median indicating that more gains, however marginal, could be had. On a relative basis, EZU has broken the downtrend line that formed in September and while I’d like to see a retest of the line to see if EZU can stay above it, the situation is improving. On a longer-term basis, we’re still in a downtrend channel which is why I’m reserving judgment on whether there has been a major trend change.
- U.S. Stocks are overbought: With today’s strong large-cap performance, the S&P 500 has crossed the 70 threshold for the RSI 14 score while short-term momentum scores have pushed all the back to the 100th percentile. Longer term scores are still outside the top quartile, but only just and the overall momentum rankings haven’t been this high since early June. Doesn’t mean the situation is going to reverse, but U.S. stocks are way too strong and need a cooling off and opening up the possibility for spill-over to other regions.
- Seasonality: Speaking from personal experience, late November and early December are the prime-times for strategic allocators to start reviewing their allocations and making changes. Typically those were done in the last two weeks of December but the light volume has pushed a lot of that into early December. After the mixed year, the annual re-balancing from U.S. out-performers to Euro under-performers won’t be as strong as last year but some of the big sell-side firms are raising their targets for Eurozone stocks versus the U.S. so we could see major strategic shifts.
- Long Term Monetary Situation: Probably the most overused argument for investing in Europe (and I should know, I’ve used it like a thousand times) is that at some point, the ECB will HAVE to start expanding their balance sheet and be aggressive about it. With the balance sheet back to 2012 levels, Europe is suffering from a major shortage of walking-around-with money (not actual currency) and will have to start throwing everything including the kitchen sink at the problem. Normally I’d say that this argument carries as much weight as “demographics” but I know it to be true and compared to the U.S. which is undergoing a form monetary tightening and potentially more fiscal tightening next year, I still say invest where the money is cheaper or going to be.
- Valuations are Rich: That whole, “they have to start printing argument” that everyone uses? Well EVERYONE has heard it already invested so from a valuation standpoint, most Europe oriented ETF’s are already seriously overbought and trading at extreme valuations. That’s always the downside of waiting or worse yet, following the herd. The best time to buy European stocks was in 2012. Now you should be adding to positions, not taking on whole new ones. If you looked at the most recent factsheet on the iShares website, EZU had a trailing 12 month p/e of 22 as of 10.31, pretty rich compared to the S&P 500 at a little over 19. Compared to prior history, if you haven’t done so yet, sign up for a free trial at ETFG.com (note, the author isn’t paid by them, he just thinks they’re really cool) and then go type “EZU” into their quant screener. Under fundamentals, you’ll see their P/E ratio close to historic highs.
- Since when do fundamentals really matter? It’s been a while, I’ll grant you that. My concern is that if the ECB finally does s%$t instead of getting off the pot, the losers will be anyone who buys more equities at these levels. Remember the run up EWJ had in early 2013 after the announcement of “Abenomics?” It peaked in May of 2013 and then started consolidating and didn’t see that old high until the summer of 2014 and has only been above it briefly since. U.S stocks had a similar experience in May of 2010 after the bottoming out in 2009 where we had to consolidate and let earnings catch up to prices which didn’t happen until October of 2011 by when the P/E ratio had fallen over 30%.
- Short Term Technical Outlook: So on a daily chart; EZU has just PLOWED through another downtrend line from September and ran smack into prior support right at the high of the day. The real question is how much strength it has to push higher? And it has to do it Wednesday because EZU is literally sitting on the downtrend line. So it pushes higher, clears resistance and then hopefully cools off to retest it, breaks down, or literally goes nowhere. Sounds like we might have a chance to buy at a better price than Tuesday’s close.
- Political Reality: Listen, I love Mario Draghi as much as the next man. He’s the real super Mario in my book and he’s vying for my #1 central banker spot with Stanley Fisher, but the man can only do so much with what he’s given. This isn’t Washington where the Chairman rules with an iron first; only the Germans can do that and they still don’t want to play ball. Draghi will have several more opportunities to jawbone the market before the end of the year but for me, the proof is in the pudding.
So far ECB covered bond purchases have amounted to a whopping 10.5 billion Euro’s which compared to the Federal Reserve is like bringing a knife to gun fight. Asset backed purchases should start this week but total issuance per FT.com in the first 3 quarters of 2014 was something like 154 billion euro’s….in 2008 it was over 800 and most are retained by the banks to use as collateral for loans. So they only way the ECB can buy what it intends would be for banks to issue hundreds of billions more…by extending loans (that they don’t want to make) and only to the highest quality buyers (who don’t want them) because that’s all the ECB will buy.
So when does the recovery start again? I stand by what I’ve said before; until Germany begins to feel some real economic pain, they have no incentive to make quick changes to their views on ECB policy and with the latest ZEW survey results, I’m sure they think the pressure is off.
For me, the next couple of days are going to be crucial. I think the recent experience with Japanese and Chinese ETF’s and their strong and unexpected performance reminds me of a great lesson I learned at my last employer. We were discussing a certain investment and someone said, “yeah, but I can’t see what the catalyst is going to be that drives it higher from here?” Does anyone EVER actually know exactly what the catalyst is going to be…ever?
If you were playing the long game in late 2013, you would have been thinking that China wouldn’t let their financial sector collapse, especially in the midst of a regime change. It was a tough quarter but after an inverse head and shoulders pattern, the Shanghai exchange took off and never looked back and is still outperforming the S&P 500 by around 500 bps in 2014. And who can keep up with the latest political machinations out of Japan but after the slowdown from their retail tax increase, it was predictable that more QE would be the solution (for investors anyway.) And for all the wailing about European lagging America, from July 2012 up until this summer EZU was actually outperforming the S&P 500, it was only after the latest weakness that Europe lagged and is now performing in-line with domestic equities.
If you’re really determined to buy some Europe and don’t want to check out some great mutual fund managers, I’d say it’s hard to go wrong with good old EZU. Like I said, EZU is literally stuck between Scylla and Charybdis or in this case, prior support turned resistance and the downtrend line that held it back for so long. Best case, it breaks through $38, makes a push towards $40 where it fails and falls back to hold at $38. It would be a lot easier to be confident about EZU then, especially if it diverged from Japanese and U.S. sentiment, preferably by outperforming on the downside.
Given the amount of volatility we’ve seen in 2014 and the distinct possibility that everything coming from Frankfurt is hot air, I’m also inclined to keep my eyes on a new offering from iShares, the iShares MSCI Europe Minimum Volatility ETF (EUMV.) It’s a relatively recent offering with a limited track record and thinly traded compared to EZU but according to Morningstar.com it was down 2.44% over the trailing three months and up 6% in the trailing one month compared to down 4.26% and up 5% for EZU. Not a huge fan of “smart beta” strategies and low vol only works when market volatility is high like in 2011 or 2014, but assuming Europe doesn’t have its act together, this could be a winner.