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Europe: One Year Later

07/29/2013

This past week, while presenting my current market expectations to a group of financial advisors and their clients in Chicago, I was asked whether “Bernanke or Greenspan?” was my favorite Federal Reserve Chairman. I quickly responded “Kuroda,” as in Haruhiko Kuroda, the current Bank of Japan Governor orchestrating the massive 2013 monetary easing program, which has appreciated the Nikkei nearly 36% this year. However, I caught myself changing my answer to “Draghi,” as in Mario Draghi, the current European Central Bank President.

How could I forget about Mr. Draghi?  I suspect I am not alone. This year’s conversation surrounding Europe has focused on summer vacation plans, not investment opportunities, let alone the 2012 summer euro crisis. But let us not forget those conversations just 365 days ago and how Mr. Draghi’s “whatever it takes” pledge to preserve the euro and unfreeze credit markets lifted global capital markets (Figure 1.1).

The argument from those who view Europe as a source of imminent disaster is that despite the appearance of improvement in Europe there still is no credible solution to providing credit to all those in need. I say the bears are wrong. I think tighter credit standards are good. The private sector in Europe does not need to lever up once again, nor do the periphery countries in the eurozone that suffer from an absence of competitiveness need more debt.

Late in the summer of 2012, Mr. Draghi helped authorize the Outright Monetary Transactions (OMT), the ECB’s unlimited bond purchase program. Its purpose was to support the eurocurrency and repair financial fragmentation in Europe. To date, it has yet to be needed. Whether Spain, Greece, Portugal, or Cyprus, not one of those countries has applied for the OMT – and I would point the apocalyptic European crowd toward that evidence.

Additionally, there is no denying the dramatic improvement in European government bond yields. On July 25, 2012, the yield on the Spain 10-year Treasury was 7.75%; today it’s at 4.62% (Figure 1.2).  Eurozone manufacturing (Figure 1.3) climbed back above 50 for the first time since July 2011 with last week’s 50.1 reading, a sharp improvement from the previous month’s 48.8.

The engine of Europe is also showing signs of strength once again despite the continued Chinese economic malaise. Germany, which heavily exports to China, has witnessed a gradual improvement in business conditions as measured by the IFO Business Climate Index (Figure 1.4).

Overall, I expect continued healing from the nearly two-year-old European recession. Better days are ahead. A simple glance at the eurocurrency (Figure 1.5) is evidence of that. Just one year ago the eurocurrency teetered at 1.2043, with talk of impending parity insight. Today, the reality of Mr. Draghi’s effort has neatly returned the euro back above 1.3000. Europe may not be completely out of the woods, but the financial stability evidenced by multiple critical metrics over the past 12 months certainly makes it “investable” once again.

Figure 1.1 S&P 500® Index (SPX) 20127-29 Terranova 1.1
Source: Bloomberg

Figure 1.2 Spain 10-Year Treasury Yield7-29 Terranova 1.2
Source: Bloomberg

Figure 1.3 Eurozone Manufacturing Index, July 2010 to July 20137-29 Terranova 1.3Source: Bloomberg


Figure 1.4 German IFO Business Climate Index, July 2012 to July 2013
7-29 Terranova 1.4
Source: Bloomberg

Figure 1.5 Eurocurrency, January 2012 to Present7-29 Terranova 1.5
Source: Bloomberg


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