Should Your Investments Include Europe?

global econ 3My Comments: Europe has been in the news a lot recently. President Obama is/was over there, it’s the 70th anniversay of D-Day, the Ukraine is a basket case waiting to get resolved, and so on. And all this time, people have investments and between dealing with the heat of summer and the need to take a vacation, somewhere, in a lonely section of their brain, circuits are opening and closing as questions about their money surface from time to time.

For those of us who find ourselves in these kinds of weeds on a daily basis, it becomes part of the background noise that leads us to make decisions on behalf of our clients, decisions that we hope will make life easier, for us and for them.

This comes from a thought leader that I think is pretty good. It’s worth your time to read. But don’t let yourself get too deep as it might interrupt your vacation.

posted by Jeffrey Dow Jones June 5,2014 in Cognitive Concord

The big story this week is the European Central Bank. Early this morning, Mario Draghi did something historic. He cut the deposit rate to negative 0.10%.

This makes them the first central bank in the world to use a negative deposit rate. It sounds pretty dramatic, right? Negative interest rates mean you pay somebody else to hold your money. Who on earth would do that?!

As it turns out, that’s exactly the point. When it costs money to hold funds on deposit, it creates a disincentive to do so. That disincentive to hold cash theoretically creates more capital movement, hopefully, consumption and investment. It’s supposed to be stimulative.

At the macro level, a negative rate makes people dislike the Euro. And a strong Euro has been one of the bigger problems over there for some time now. Strong currencies make a country’s exports relatively more expensive, and that translates into lower GDP. Supposedly a weaker Euro might stimulate a bit more economic growth.

Europe is in a really weird spot. They have a single currency and they have a central bank, but they don’t have a political union nor do they have any kind of unifying fiscal union. It’s just a bunch of really different countries that all share a currency. It’s the biggest experiment in monetary history.

Look, they’ve gotta do something. Inflation has been trending lower and lower and lower and is now officially in the Danger Zone.

It’s been a long time since we’ve talked about this. But that chart is one of the most important charts in the world right now. The Eurozone is the world’s largest economic entity. And the world’s largest economic entity has been pretty sick for a while. They’re doing everything they can to keep this next chart from dipping back into negative territory:

Will Europe be OK? Will GDP hold? Let’s ask the market:

That’s Europe, folks.

It’s up over 50% in the last two years.

Let me ask you a question: is this a market that is concerned about recession?

Is this a market worried about deflation?

Clearly, equity investors over there think everything will be just fine. Markets are forward looking things and what they see right now is no recession, no deflation, no problem. They could certainly be wrong about that, but when markets do get it wrong, they tend to react rather quickly when evidence starts emerging that they are. This is the equity benchmark that investors really ought to be paying attention to right now. I think a(nother) European recession is the single biggest risk for investors right now, or at least the one with the biggest possible global impact relative to its probability.

I’ve been bullish on European stocks since last summer. Alpine Advisor Pro subscribers will remember our macro move away from the U.S. and into more favorably-valued Europe.