Wheat in Euroland

2011, europe, foreign markets, stocks, value 2 Minutes

Over the past year, there’s no doubt that Europe has dominated the headlines of the world’s financial news – and for good reason too.  With one country after another falling victim to the “bond vigilantes,” the Eurozone’s very existence is being called into question. As investors small and large look for an exit, anything that smells of the region is being left behind.  Keep in mind, however, that not everything in Europe is doomed.  The source of the problem, really, is public debt.  While I think it’s prudent to steer clear of certain European government bonds, I don’t think that all European assets need to be avoided like the plague.

European equities, for example, look cheap.  Of course, stocks, in general, may suffer further should the debt issues worsen, but we shouldn’t miss the bigger picture. The economic engine in Europe is not dead, and European equity markets still have value – but try telling that to a herd of fleeing investors.  I have no idea how low prices will go, but what I do know is that prices look low relative to historical norms, and also relative to the U.S. and emerging market equities.  Figure 1 shows the current and average P/E ratios for the EAFE, EMEA, and SP500 indices (proxies for foreign developed, emerging, and U.S equity markets, respectively).  Note that while both the EAFE and EMEA indices are sporting P/E’s below 10x, the EAFE (which includes developed Europe) is trading 30% below its historical average (versus 11% for the EMEA).

Figure 1
Source: MSCI, Yahoo Finance, BCM
I reiterate that this doesn’t mean prices won’t go any lower.  On the contrary, they probably will, but I have never been good at timing market peaks or bottoms.  So as the great Oracle of Omaha once said, “I would rather be approximately right than precisely wrong.”  What I am saying is that European markets are being sold off indiscriminately out of distrust, disgust, and outright fear.  And while we may not have found a bottom, there are likely to be some outstanding values in European equities for those who care to separate the wheat from the chaff.

Victor K. Lai, CFA

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