Investors may recall a period of cold, dark days for the U.S. dollar. Short-sellers piled on amid speculation that major foreign holders like the Chinese would dump the sliding currency as America drowned in a sea of debt. Those dismal days, after all, were just this winter.
Of course, things couldn't be more different on Wall Street now. The greenback has rallied mightily, and many are now forecasting an unlikely, dreamlike scenario for the U.S. economy. Now, nothing can go right for Europe. Predictions range from an outright breakup of the eurozone to the comparatively happier forecast of a deep recession as its peripheral countries attempt to get their fiscal houses in order.
And the tumbling euro, the new favorite for short-sellers, is seen as validation of all this negativity. But investors should maintain some perspective: The ubiquitous gloom surrounding Europe's common currency might in fact present a buying opportunity, much as it has in the past.
Spain, Portugal and Greece Aren't the Whole Story
For starters, the sliding euro has a major silver lining for Europe -- one that gets overlooked in the cacophony of pessimism surrounding the impact of austerity measures. The drop in the euro tacked on about 1% to real GDP for the region, analysts at Credit Suisse wrote in a research note on Monday, and "recent weakness in the euro offsets all the tightening measures announced in recent weeks in peripheral Europe."
Nor are things going as badly as the constant focus on sluggish, overly indebted economies like Spain, Portugal and Greece might suggest. Germany's economy is 50% larger than all the so-called peripheral countries combined, and it's witnessing a strong manufacturing rebound.
Leading indicators point to growth of more than 3% for Europe, Credit Suisse analysts point out -- well above the consensus expectations of 1.2% and in line with what JPMorgan recently forecast. Indeed, "Europe now has the best rate of change in economic momentum," Credit Suisse notes.
Where Europe Looks Better Than Most
It's true that nations like Greece that subscribe to the strongest forms of welfare capitalism have racked up unsustainable levels of debt. But taking into account aggregate debt like corporate and consumer balance sheets paints a strikingly different picture.
Aggregate leverage in Europe is 220% of GDP. Compare that to 270% for the U.S., 300% for the U.K., and 363% for Japan. The savings ratio in core European countries is six times as high as it is in the U.S., and the Continental economies will have to tighten fiscal policy by just 3% to stabilize their government debt-to-GDP ratios, assuming a normal recovery. That compares to between 7% and 8% for the U.S., U.K. or Japan to accomplish the same, according to Credit Suisse.
Indeed, the fixation with the sliding euro amid speculation that, short of an outright breakup, it will lose its reserve currency status, may be misplaced as well. The euro has long been overvalued on measures like purchasing power parity -- a boost, ironically, fueled by China's supposed desire to diversify into a reserve currency other than the dollar a few years ago and then buttressed by Europe's relatively prudent response to the financial crisis.
While the euro could fall below the $1.20 level compared to the U.S. dollar, Credit Suisse forecasts, that would eventually boost earnings per share for European stocks by 13%. Europe has outperformed other markets 88% of the time in a currency-hedged portfolio when the euro has weakened in the past.
Propping Up the Bond Market
Other investors, too, are starting to view European equities as undervalued. High-quality indexes such as the Euro Stoxx 50 now trade at about 10 times forward earnings, the cheapest valuations since April 2009. Profit estimates rose 2.5% in April to post the biggest gains since 2006.
So, instead of freaking out about a sliding euro, perhaps investors should watch sovereign bond yields for signs of turbulence instead. And there, the European Central Bank deserves enormous credit for stabilizing the situation with a relative pittance of capital. So far, only 16.5 billion euros have been deployed to prop up sovereign bonds in secondary markets, the ECB announced on Monday. Plenty of dry powder remains.
Of course, investors should expect much more drama to come out of Europe. A debate is already under way about whether the ECB blinked by buying sovereign bonds and compromised its independence. Absurdly, the ECB remains hawkish on inflation, and the question of whether its intrusion into markets technically qualifies as "quantitative easing," given the bank's moves to fund the purchases, is somehow a hot-button issue.
But behind the barbs that, like the falling euro, evoke such a media frenzy lies a Europe that's recovering. And a growing number of investors seem to be taking notice.
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