Political paralysis here and in Europe drives stocks down
For years we’ve been warned that China would someday stop buying Treasury bonds, driving interest rates up and bringing on the dreaded day of reckoning. That day may still be out there, but I don’t remember many warnings concerning French bonds, or Italian bonds, or even Greek bonds before 2010.
But here we are with European bond yields rising, indicating that investors recognize the risks in Europe, while US treasuries remain anchored at historically low levels. As the Euro-crisis festers, the relative strength of the US economy and US corporations becomes more obvious.
Maybe the US will be the place to hide in the event of a breakup of the Euro? Here’s a list of strengths found in the US, but largely absent in Europe:
- United States versus fractured Eurozone
- Demographics
- Flexible labor markets
- Cheap energy sources
- Low currency value
- Technological innovation
- Entrepreneurial activity
- Best universities
- Many of the best companies in the world
- Deep/liquid capital markets
With the failure of the so-called Super Committee and continued tepid growth, it is easy to forget these advantages. We think it would be better for investors to be thankful rather than fearful at the moment, although we understand the fear.
The Euro will likely split into smaller groupings of countries in the next year and we share everyone’s worry that the event will produce nasty reactions in most markets around the world. But two observations are in order:
- Markets have been weak for a long time, and we’re not just talking about the current correction. The ratio of prices to earnings (PE) has been falling for years even as earnings hit record highs. Maybe the market is discounting the breakup in Europe in advance, much the way it did with Apple’s stock and Steve Jobs’ passing.
- The Euro breakup will be painful in the short-term, but would be very beneficial in the long-term. The Euro has caused a huge mispricing of assets, in this case government issued bonds. Just as we in the US made the mistake of thinking all mortgage debt was triple A, the Europeans loaned money to Greece and the others at the same rates as they loaned money to Germany. This mistake will be fully recognized when the Euro comes apart. So once the different regions of Europe have currencies that fit the way they run their governments, the painful adjustments will take place and European growth can resume.
Yes, maybe we are far too optimistic. (And money managers who mention the long-term usually have little to show in the way of short-term performance!) But the list of strengths above, the still positive prospects in Asia, and the great values to be found in stocks at the moment, provide us with the confidence to write the foregoing.
A Happy Thanksgiving to you and your families.
Best regards,
Daniel A. Ogden
