Eurozone equities are cheap. Should you buy eurozone equities? First let’s look at exactly how cheap they are. Look at the Shiller p/e (price/earnings) ratio for France and Germany, says Société Générale’s Dylan Grice, and you’ll see they are at levels not far off those of the crash of 2008 and the levels they hit in the 1970s.
Given that the Shiller p/e is one of the few historically successful predictors of long-term returns, that’s encouraging. We know that, in general, if we buy things when the Shiller p/e is low, we will make good returns over time. We can’t be sure of the short term, of course, but mostly at MoneyWeek we are investors not traders, so that doesn’t necessarily matter.
We also know that in the past “cheap stuff has outperformed expensive stuff pretty much regardless of the macro regime”. Events are unpredictable. The fact that valuations pretty much always revert to a mean over time is not. Look at it like this and it seems to make sense to jump into the market right now, particularly given that there are several good European investment trusts around trading on nice discounts – Fidelity European Values or the JP Morgan Smaller Companies European Trust (which is currently on a 20% discount to its net asset value), for example.
But I’m not sure you want to do so too enthusiastically. Why? Because while mostly cheap stocks do well regardless of the macro economic environment, you don’t often get a macro environment quite like this. The euro has always been a political construction. Now it needs some kind of economic cohesion if it is to survive. Short term the European Central Bank probably needs to dump its pretensions of commitment to hard money and start with serious money printing. Longer term, as James Ferguson wrote here a few weeks ago, Europe needs fiscal integration, tough fiscal rules and an explicit commitment that all countries back all their fellow members’ debt (a eurobond). Will this happen? The consensus view remains that it will. But there is a rising possibility that it will not – that the eurozone will suddenly break down in a thoroughly disorderly way.
Some observers think this is the best end for a bad currency. I suspect they aren’t thinking very hard. A recent report from UBS lays out the consequences of a country leaving the euro. First sovereign default. Then corporate default. Then a collapse of the domestic banking system, followed immediately by bank runs across the eurozone. Then the rise of protectionism, the collapse of trade and a whole lot of civil disorder (see our blog for more on this). If this happens, none of today’s stock prices can possibly be cheap enough. I suspect the money printing will start before we get to this. But if you think it’s a possibility, how do you hedge against it? By not holding any euro assets at all