Draghi Melt-Up Makes Europe Emerge From Germany to GreeceAlexis Xydias
The biggest European rally in 19 months is leaving virtually no stock behind, pushing up equity prices from Frankfurt to Athens as investors plow money into the region at the fastest rate since 2002.
The Euro Stoxx 50 Index has climbed 21 percent since reaching its 2013 low on June 24, with every constituent but three advancing, according to data compiled by Bloomberg. Banks, automakers and phone firms are leading gains on prospects earnings will expand as the region’s financial system heals and its longest recession ever ends.
Lured by the lowest valuations compared with the rest of the world and the best returns relative to emerging economies in more than a decade, mutual fund clients have sent fresh cash to European money managers for 15 straight weeks. European Central Bank President Mario Draghi is underpinning markets with a pledge to protect the euro even as a recovery takes hold in everything from manufacturing to Spanish gross domestic product.
“By Draghi standing up and saying what he said out loud, it was the first time that a politician of relevance in Europe was prepared to react and be ahead of events,” said David Moss, a portfolio manager at F&C Asset Management in London, which oversees $149 billion. “The economy has stopped being a headwind. The underlying prospects are not great by any stretch of the imagination, but are much better.”
The Euro Stoxx 50 advanced 0.7 percent to 3,038.96 yesterday, leaving the index up 15 percent for 2013 after closing at a 2 1/2-year high on Oct. 22. The measure tumbled 35 percent between February and September 2011 as the debt crisis that forced five nations to accept a bailout worsened. The gauge fell 0.1 percent at 3:20 p.m. in Frankfurt today.
Since taking over at the ECB in November 2011, Draghi has reduced interest rates to a record low, vowed in July 2012 “to do whatever it takes to preserve the euro,” and said this year that borrowing costs would remain low for an extended period.
His actions helped bring down Spanish and Italian 10-year government bond yields to 4.14 percent and 4.15 percent from as high as 7.75 percent and 7.48 percent. The euro has climbed 7.9 percent since July 9 to a near two-year high against the dollar.
“Europe is a in a very difficult situation but it’s moving in the right direction,” Andrew Goldberg, who helps oversee $1.5 trillion as global market strategist at JPMorgan Asset Management, said in a presentation in London on Oct. 21. “It’s not just core Europe, southern Europe is improving too. We are seeing lots of opportunities.”
Draghi has gone beyond the efforts of predecessor Jean-Claude Trichet to end the euro-region debt crisis, declaring there aren’t any “taboos” at the ECB. Draghi is proactive, while Trichet was more conservative and believed central banks exist to fight inflation “and needed to avoid moral hazard,” according to Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam.
The ECB introduced its program of longer-term refinancing operations, or LTROs, for banks in late 2011 and early 2012, when the region faced a cash crunch. It also unveiled the Outright Monetary Transaction program, which would buy sovereign bonds to cap borrowing costs for a nation that requested assistance. It hasn’t introduced a direct bond-purchase program like the one used by the Federal Reserve in the U.S.
The actions have coincided with strengthening economic data. A manufacturing index for the 17-nation currency bloc rose to 50.3 in July, according to a survey of purchasing managers by London-based Markit Economics, the first time since July 2011 the gauge topped the 50 level that indicates growth. Spain emerged from a two-year recession in the third quarter, with GDP expanding 0.1 percent, the Bank of Spain estimated this week.
“We have the initial signs in the figures coming out that Europe might be making some progress behind the scenes,” Louise Kernohan, who helps oversee $312 billion at Aberdeen Asset Management in London, said in an interview on Oct. 22. “Despite the strong performance of Europe, valuations remain attractive and multiples are relative low.”
The Euro Stoxx 50 is 32 percent cheaper than the MSCI World Index of developed-market equities when compared to the assets held by the companies in the gauges, according to data compiled by Bloomberg. The discount fell to a record low of 40 percent in May 2012, data starting in 2001 show.
Relative to profits, the Euro Stoxx 50 trades at 13.6 times this year’s estimated earnings, Bloomberg data show. That compares with valuation ratios of 15.8 for the Standard & Poor’s 500 Index and 18.4 for Japan’s Nikkei-225 Stock Average.
The euro-region economy will grow 1 percent in 2014, following two years of contraction, according to forecasts from 54 economists compiled by Bloomberg. That’s still slower than the 2.6 percent expansion estimated for the U.S., 1.6 percent for Japan and 7.4 percent for China.
Richard Lewis, who helps oversee $261 billion as head of global equities at Fidelity Worldwide Investment, said Draghi’s policies may backfire because he is reducing, rather than increasing, the ECB’s balance sheet.
The ECB’s balance sheet shrank to 2.33 trillion euros ($3.2 trillion) in the week ended Oct. 18, from 3.1 trillion euros in June 2012 as banks repaid funds they had borrowed to ease liquidity at the height of the debt crisis. Meanwhile, the Fed’s account has grown every month this year to a record $3.81 trillion from $2.92 trillion at the start of 2013, according to Bloomberg data.
“I would not give so much credit to Mario Draghi,” Lewis said in a phone interview in London on Oct. 22. “The markets are busy listening to Draghi but, behind the scenes, the ECB has done what it has always done. Our fund managers are not overwhelmed by the strength of the European story. I don’t think we are quite finished with the European crisis.”
European investments will have to survive tests on banks’ balance sheets and the renegotiation of bailout programs. Lending to companies and households in the euro area fell the most on record in August, the ECB said Sept. 26, signaling the economy is still struggling to recover.
Norway’s sovereign wealth fund, the world’s largest, warned today that stock market gains may reverse and said it won’t buy more shares. Yngve Slyngstad, chief executive officer of Norges Bank Investment Management, Europe’s biggest equity investor, said at a press conference in Oslo that the fund is preparing for a “correction” in equities.
The Euro Stoxx 50’s gain from June 24 to Oct. 22 was the steepest advance since the first quarter of 2012, when it rose 22 percent in the same length of time, according to data compiled by Bloomberg. Compared with the MSCI Emerging Markets Index, the euro-region gauge is having the best year since 2000, the data show.
Banks led the rally over the past four months, with Paris-based Societe Generale SA and UniCredit SpA, Italy’s biggest lender, surging more than 45 percent.
The ISEQ Index in Ireland and the ASE Index in Greece, the first two nations to receive European Union-led bailouts, have soared more than 28 percent this year to lead gains among 18 national benchmarks in western Europe. Dublin-based Independent News & Media Plc and Athens-based Aegean Airlines SA rose the most, with jumps of more than 180 percent. Germany’s DAX Index has advanced 18 percent in 2013, reaching a record.
Investors poured about $22.2 billion into the region’s stock funds in the 15 weeks through Oct. 9, according to data from research firm EPFR Global Inc., marking the longest stretch of uninterrupted weekly inflows since May 2002.
Global money managers have the highest allocation to euro-region stocks since June 2007, a monthly survey by Bank of America Corp. showed Oct. 17. They held less of the shares than are represented in indexes for most of the 2008-2012 period.
“The crisis started also because capital was going out of Europe,” Alberto Gallo, head of European macro research at Royal Bank of Scotland Group Plc, said in an interview on Bloomberg Radio’s “Bloomberg Surveillance” on Oct. 21. “Now, there is some potential for this circle to reverse and become a virtuous circle with capital coming back. We are positioned for Europe melting up into year-end.”
Moss at F&C says Europe’s rally will likely expand, citing the prospect for earnings growth. Profits at companies in the Euro Stoxx 50 are still 50 percent below the peak in 2007, according to Bloomberg data, while those for the S&P 500 are 23 percent higher.
European stock indexes will climb 11 percent by the end of 2014, according to the average forecast in a Bloomberg survey of eight market strategists.
For David Herro, who helps oversee about $106 billion as chief investment officer at Harris Associates LP in Chicago, valuations for European businesses and their sales to emerging markets make the shares attractive.
“Europe is a great opportunity,” he said in a phone interview on Oct. 23. “The European economy seems poised for some recovery.” Stocks “haven’t bounced back completely yet.”