More than two weeks ago (on Friday June 4th), we sent an email message to our clients explaining that some metrics and trends make us uncomfortable. Furthermore, we discussed that some trailing stops were initiated. We do not believe that the fundamentals face major issues. Moreover, we do not believe that the fundamentals point to any major correction. We simply believe that some metrics such as the market’s breath (number of advancing vs. declining stocks), the Put/Call Ratio, the declining number of securities reaching new highs, the copper/gold ratio, and other similar metrics, point to a possible market consolidation.
Immanuel Kant taught us that reflection without life is empty, and that life without reflection is blind. One of America’s best-known philosophers, William James, reflected on Socratic teachings about life when he reminded us that an unexamined life is not worth living, while an unlived life is not worth examining. Given that the financial world is part of our life, we are of the opinion that at this time of consolidation, it might be prudent to reflect on European prospects and examine their potential for an upswing. However, before we endeavor into that discussion (and also state a few facts about the Euro), allow us, please, a few words about the reasons that led to this past week’s market turmoil which brought the Dow Jones down by 3.45% and the S&P 500 down by almost 2%.
Since the 1990’s, the Fed and other central banks have been following a policy of forewarning the markets about its thinking (forward guidance). Such policy, along with ZIRP (zero interest rate policy) and asset/bond purchasing, has become the cornerstones of a historical market upswing. The whole mission can be summarized in two words: moral suasion. The Fed is talking the markets into complying with its yield curve goals while pretending that the market is in charge.
So, what happened last Wednesday? Almost nothing. The Fed did not change its short-term rate policy, and it also did not change its asset buying program. It only stated that it will be paying a slightly higher rate to the banks’ reserves with the Fed. The markets understood that the Fed may be having second thoughts on what the actual inflation rate will be and how temporary the higher inflation will turn out to be. From that point on, the consolidation started.
So, as the consolidation starts, we are wondering if it is time to deploy more capital into European holdings. In a nutshell, we could say that European stocks – from a valuation perspective – look attractive relative to US stocks. Having said that, we still believe that the Euro is a dysfunctional currency and one of the most important causes of the crisis that took place in the Eurozone starting in 2010. This is not the place to argue, again, about the Euro’s dysfunctionalities, however we all need to be reminded that scapegoats were invented, rather than admitting that the root cause of that crisis was the widespread misalignment of costs advanced by the Euro. Having said that, we couldn’t deny the fact that the Euro brought with it some important advantages, and while we still believe that the cons of the Euro outweigh the pros, we appreciate the efforts to save it as the consequences of any potential Euro demise could be catastrophic.
Nowadays, most analysts would agree that the results achieved by the draconian European austerity could have been achieved by a combination of different measures that would have avoided the depression that some countries experienced (due to costs misalignments), which in turn undermined their long-term potential. It’s interesting to also note that countries – such as Iceland – that had similar fault lines (credit overextension, fiscal profligacy, etc.), were able to claw back their competitiveness and recover much faster than similar Eurozone countries that were bound by the sclerotic monetary regime that the Euro imposed.
In the midst of the year 2021, there are Eurozone countries where the GDP per capita is the same (if not lower) than it was back in the year 2000. This fact alone contradicts the euphoria of the early 2000s when the Euro was created, and certainly contradicts the European historical record where in the years following World War II, Europe transformed itself into a model of prosperity and democracy. The reality is that Europeans are tired of sclerotic policies, disappointed by promises and unmet expectations cultivated by unrealistic dreams that were fertilized by mismanagement and squandered by Eurocrats. The result has been a retreat from classical liberalism into a cocoon of phobias, trying to invent scapegoats. Moreover, that retreat has also resulted in the rise of ethnonationalist and fascist ideologies, which seems to be the outcome of tribalizing and radicalizing politics by boneheads who never understood the value of classical liberalism (some of those symptoms might be equally applicable to the US).
But let’s return to valuation metrics for European companies. In our humble opinion, whether we are talking about intrinsic valuation methods (such as discounted cash flows) or relative valuation metrics (comparing European companies with comparable US-based companies), we believe that European companies are cheaper than US-based ones. In addition, their scalable growth along with their sustainable margins makes them attractive when we consider two additional factors: First, their Price-Earnings (PE) ratios adjusted for the growth of their earnings (PEG ratio) signify opportunities across several sectors. Second, and under ceteris paribus conditions (assuming no major market correction that will force investors to the safety of US bonds and the dollar), for the next few months the dollar may experience a downward pressure against the Euro which will enhance returns from exposure to European holdings.
Furthermore, when we look at the same metrics that made us skeptical about US markets two weeks ago, we discover that those same metrics point to a rather bullish sentiment for European holdings.
There is little doubt that as long as our minds adjust to an object (such as valuation), we are doomed to a frustrating skepticism reflected by Descartes’s and Hume’s writings. However, if instead of the mind conforming to an object, we let the object conform to the mind as Kant taught us in his Prolegomena to Any Future Metaphysics, then we may discover that some of today’s valuations are mere pretensions of an illusionary reality created by easy money policies which are projected to be with us for the foreseeable future.
On Rates, Monetary Policy, and Valuations: Is it Worth it to Take a Closer Look at Additional European Portfolio Exposure?
Author : John E. Charalambakis
Date : June 22, 2021
More than two weeks ago (on Friday June 4th), we sent an email message to our clients explaining that some metrics and trends make us uncomfortable. Furthermore, we discussed that some trailing stops were initiated. We do not believe that the fundamentals face major issues. Moreover, we do not believe that the fundamentals point to any major correction. We simply believe that some metrics such as the market’s breath (number of advancing vs. declining stocks), the Put/Call Ratio, the declining number of securities reaching new highs, the copper/gold ratio, and other similar metrics, point to a possible market consolidation.
Immanuel Kant taught us that reflection without life is empty, and that life without reflection is blind. One of America’s best-known philosophers, William James, reflected on Socratic teachings about life when he reminded us that an unexamined life is not worth living, while an unlived life is not worth examining. Given that the financial world is part of our life, we are of the opinion that at this time of consolidation, it might be prudent to reflect on European prospects and examine their potential for an upswing. However, before we endeavor into that discussion (and also state a few facts about the Euro), allow us, please, a few words about the reasons that led to this past week’s market turmoil which brought the Dow Jones down by 3.45% and the S&P 500 down by almost 2%.
Since the 1990’s, the Fed and other central banks have been following a policy of forewarning the markets about its thinking (forward guidance). Such policy, along with ZIRP (zero interest rate policy) and asset/bond purchasing, has become the cornerstones of a historical market upswing. The whole mission can be summarized in two words: moral suasion. The Fed is talking the markets into complying with its yield curve goals while pretending that the market is in charge.
So, what happened last Wednesday? Almost nothing. The Fed did not change its short-term rate policy, and it also did not change its asset buying program. It only stated that it will be paying a slightly higher rate to the banks’ reserves with the Fed. The markets understood that the Fed may be having second thoughts on what the actual inflation rate will be and how temporary the higher inflation will turn out to be. From that point on, the consolidation started.
So, as the consolidation starts, we are wondering if it is time to deploy more capital into European holdings. In a nutshell, we could say that European stocks – from a valuation perspective – look attractive relative to US stocks. Having said that, we still believe that the Euro is a dysfunctional currency and one of the most important causes of the crisis that took place in the Eurozone starting in 2010. This is not the place to argue, again, about the Euro’s dysfunctionalities, however we all need to be reminded that scapegoats were invented, rather than admitting that the root cause of that crisis was the widespread misalignment of costs advanced by the Euro. Having said that, we couldn’t deny the fact that the Euro brought with it some important advantages, and while we still believe that the cons of the Euro outweigh the pros, we appreciate the efforts to save it as the consequences of any potential Euro demise could be catastrophic.
Nowadays, most analysts would agree that the results achieved by the draconian European austerity could have been achieved by a combination of different measures that would have avoided the depression that some countries experienced (due to costs misalignments), which in turn undermined their long-term potential. It’s interesting to also note that countries – such as Iceland – that had similar fault lines (credit overextension, fiscal profligacy, etc.), were able to claw back their competitiveness and recover much faster than similar Eurozone countries that were bound by the sclerotic monetary regime that the Euro imposed.
In the midst of the year 2021, there are Eurozone countries where the GDP per capita is the same (if not lower) than it was back in the year 2000. This fact alone contradicts the euphoria of the early 2000s when the Euro was created, and certainly contradicts the European historical record where in the years following World War II, Europe transformed itself into a model of prosperity and democracy. The reality is that Europeans are tired of sclerotic policies, disappointed by promises and unmet expectations cultivated by unrealistic dreams that were fertilized by mismanagement and squandered by Eurocrats. The result has been a retreat from classical liberalism into a cocoon of phobias, trying to invent scapegoats. Moreover, that retreat has also resulted in the rise of ethnonationalist and fascist ideologies, which seems to be the outcome of tribalizing and radicalizing politics by boneheads who never understood the value of classical liberalism (some of those symptoms might be equally applicable to the US).
But let’s return to valuation metrics for European companies. In our humble opinion, whether we are talking about intrinsic valuation methods (such as discounted cash flows) or relative valuation metrics (comparing European companies with comparable US-based companies), we believe that European companies are cheaper than US-based ones. In addition, their scalable growth along with their sustainable margins makes them attractive when we consider two additional factors: First, their Price-Earnings (PE) ratios adjusted for the growth of their earnings (PEG ratio) signify opportunities across several sectors. Second, and under ceteris paribus conditions (assuming no major market correction that will force investors to the safety of US bonds and the dollar), for the next few months the dollar may experience a downward pressure against the Euro which will enhance returns from exposure to European holdings.
Furthermore, when we look at the same metrics that made us skeptical about US markets two weeks ago, we discover that those same metrics point to a rather bullish sentiment for European holdings.
There is little doubt that as long as our minds adjust to an object (such as valuation), we are doomed to a frustrating skepticism reflected by Descartes’s and Hume’s writings. However, if instead of the mind conforming to an object, we let the object conform to the mind as Kant taught us in his Prolegomena to Any Future Metaphysics, then we may discover that some of today’s valuations are mere pretensions of an illusionary reality created by easy money policies which are projected to be with us for the foreseeable future.