Despite this week’s weakness, U.S. stocks are near all-time highs.
But while investors digest the Fed’s tapering plans and try to make sense of a never-ending stream of conflicting data, European shares and Chinese shares have quietly been rallying.
BIG OUTPERFORMANCE
Since the beginning of July, the S&P 500 is up a little more than 3%. Spanish stocks, meanwhile are up over 15%, and French and Chinese stocks are up by about 11%. Even Germany, where prices were less depressed, has had a nice bounce. German stocks are up nearly 8%.
At first blush, it might seem a bit odd that the European and Chinese markets are leading. After all, in the “risk on / risk off” conditions that have dominated the market for the past several years, European and emerging market stocks have tended to move the same direction as the U.S. market, albeit with more extreme swings.
Furthermore, “everyone” knows that China is slowing and that Europe is mired in a debilitating crisis, right? After all, Spain and the UK are in the midst of heated squabble over ownership over Gibraltar that threatens to poison the relationship between two old allies, and Italy’s government is facing a paralyzing crisis over the conviction and possible expulsion from politics of Silvio Berlusconi. Shouldn’t investors be panicking?
IT’S ABOUT VALUATION
There are a couple factors at work here. To start, there is valuation. European shares are roughly a quarter cheaper than American and Chinese shares trade hands at single-digit P/E ratios. At current valuations, a lot bad news is already priced into these markets.
Furthermore, while all the talk in the U.S. is on Fed tapering, the European Central Bank has taken great pains to emphasize it has no intention of backing off any time soon. And China is already on the other side of this, having already gone through a tightening cycle. Economic data is also coming in better than expected in both Europe and China.
And finally, don’t underestimate crisis fatigue, particularly in the case of Europe. Europe has been in a perpetual state of crisis since 2010, yet it seems to always find a way to paper over its problems and muddle through. Investors have simply stopped reacting to bad political news.
ACTION TO TAKE
Overweight your portfolio with European exposure. I recommend the iShares MSCI Spain (EWP) and iShares MSCI France (EWQ) ETFs. Also, start allocating to emerging markets starting with China. I recommend the iShares China Large Cap ETF (FXI).
Disclosure: At time of writing, Sizemore Capital was long EWP and EWQ.
