This article was originally published on RealMoney.com on October 23rd at 2pm EDT
The US Dollar’s recent strengthening against other major currencies may have slowed, but it has not stopped—and it has certainly not reversed course. As we have seen with Quantitative Easing, the results of a massive shift like this do not always show themselves immediately. And it has been massive.
Below is a chart reflecting the USD’s relative performance against the Euro and Yen over the past six months:
6% may not sound like much, but consider that over the four years prior the greenback had been losing value in relative terms:
We are now seeing downside surprises on both earnings and guidance from US blue chips like Boeing (BA), Coca Cola (KO), McDonalds (MCD), and IBM (IBM). Now these are still US-based companies (as of this writing, anyway) who do a huge portion of their business outside the United States. You have to believe the strong dollar has impacted their overseas results. It’s not just downbeat numbers and guidance that cause stocks/sectors to fall, necessarily; it’s the element of “surprise” to the downside that creates added (and often irrational) selling pressure.
If large US companies have the capability to issue surprisingly poor numbers and guidance—and we are comfortable assigning blame to a strong dollar—is it possible the opposite holds true for their European competition?
Yes, we are hearing about how the Eurozone and even its strongest player, Germany, are on the “verge” of recession. That sounds pretty bad. Just the word recession has a negative connotation, especially among men. A recession simply means that the GDP of a region shrunk a little bit, either over the most recent quarter or year. Okay.
The Silver Lining of Downbeat Expectations
Good entry points into stocks or funds do not tend to coincide with known, clear, positive catalysts. Of course as investors we want to know what could go right, just as we want to know what could go wrong. Securities become priced attractively when nobody wants them—when the general consensus is that there is “just too much risk” right now. Is there more risk in European than US stocks right now? Why?
To me risk means potential downside, and from current levels I see more opportunity for upside surprises than I do for further share price depreciation. Here’s why:
1. Favorable foreign exchange conditions could lead to a more positive picture for European companies than many are expecting.
Below is a chart reflecting the price of the Vanguard FTSE Europe ETF (VGK) overlaid with the CurrencyShares Euro ETF (FXE), an index reflecting the Eurozone currency’s strength (or lack thereof).
You ought to be able to see a direct correlation between the FXE taking a dive and a short-term bottom forming for VGK shares. Maybe they’re not growing as quickly as investors would like, but a weakening currency may serve as a counterintuitive catalyst for slow, or slowing, growth.
2. European stocks are priced for [almost] the worst case scenario.
They are priced for recession, not depression. While another global depression is certainly possible if not unavoidable at some point in our lifetimes, it is extremely unlikely today due to global central bank coordination. There is a level of interconnectedness, if not codependency, among major economies on each other that we’ve never seen before. It is literally in our best interest that the world’s other economic powerhouses are growing, and vice versa. Why not buy the cheapest one with the best yield? At today’s valuations VGK pays an annual dividend of 4.52%—more than twice that of the 10 year US Treasury, and 50% more than a 30-year US Treasury.
The odds of an investment today in Treasury Bonds being worth more than a basket of high quality, large-cap European stocks over the next decade is unlikely to say the least.
3. US Companies could—and probably should—go on a European shopping spree, snapping up competition at rock bottom prices.
So far we’ve only heard about such deals for the sake of tax inversion. But US corporations are as fiscally healthy as ever and such moves might make a lot of sense, especially with their easy and inexpensive access to our debt markets. This could do quite a bit to pump up valuations across Europe.
4. Last is the most obvious, and most talked about, but also perhaps the most underestimated—stimulus.
ECB President Mario Draghi’s promsies are starting to feel a little boy who cried wolf-ish. But what if one of these rounds of stimulus actually has the intended effect? Thus far the efforts have simply been too small, but it appears Germany may be recognizing it needs to concede to some non-austerity measures for its own sake.
You might consider initiating a position or adding to your existing positions. The yield is juicy and we believe the current risk-reward story is compelling.
If you have questions or feel we might be able to help you, please don’t hesitate to give us a call.
Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main
Adam Scott’s profile on TheStreet.com can be found here.