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10 bargains to look for after the next round of the euro debt crisis
03/05/2013 8:30 am EST
I bring this up now because 1) I think that Draghi’s promise is going to be challenged and challenged hard—with its very real flaws and limits exposed to scrutiny by the financial markets—over the next few months, and 2) that this renewal of the euro debt crisis has the potential to take the shares of some very good European companies—companies you’d like to own for the long term—down to bargain levels again.
This post has two purposes: first, to run through, briefly since I’ve covered most of this ground before, the reasons to think we’re about to see a new round in the euro debt crisis, and second, to give you a list of 10 European stocks that I’d snap up if their prices fell in a new round of the crisis.
Let me take you back to the scary days of July 2012. Yields on Spanish 10-year government bonds had climbed to 7% and then kept on climbing. Analysts and economists issued daily hand-wringing warnings saying that above 7% the burden of Spanish debt on a struggling Spanish economy was unsustainable. Spain seemed headed to a bankruptcy, a bailout, a departure from the euro, or a combination of all three.
Italy wasn’t far behind. The yield on Italian 10-year government debt hadn’t yet reached 7%, but at 6.597% it was clearly headed in that direction.
Which raised the hand wringing to another level: The EuroZone probably didn't have the resources to handle a bailout of Spain or Italy. But it certainly couldn’t handle a bailout for both countries.
Draghi’s speech stopped that trend dead in its tracks. The “whatever it takes” promise had credibility since it followed on the central bank’s huge longer term refinancing operation (LTRO) that provided 1 trillion euros in cheap money to European banks. That move had shown that Draghi would act and act big. When the July promise was fleshed out with a new Outright Monetary Transactions (OMT) pledge that said the European Central Bank was prepared to buy unlimited amounts of government bonds of maturities of three years or less of any country in bond-market distress that was enough to turn financial markets around.
The yield on 10-year Italian government bonds—which had peaked at 6.597% before Draghi’s speech—fell to 4.129% by January 25, 2013. The yield on 10-year Spanish government bonds—which had peaked at 7.498%--fell to 4.904% on January 10, 2013.
European stock markets recovered too. The ADRs (American Depositary Receipts) of Spain’s biggest bank, Banco Santander (SAN) climbed from $4.89 on July 24 to $8.81 on January 25, 2013. Shares of German car giant Volkswagen (VOW3.GR) rose from 118.75 euros on June 27 to 186.75 euros on February 2, 2013. Even a French consumer stock such as dairy maker DANONE (DANOY in New York) got into the act rising from $11.33 on July 25 to $14.28 on February 19.
Recently, though, some of the gloss has come off those gains. The yield on the Italian 10-year bond has climbed from 4.129% on January 25 to 4.79% on March 1. The yield on the 10-year Spanish bond has increased from 4.904% on January 10 to 5.10% on March 1. Banco Santander ADRs are down 14.9% as of March 1 from their January high. Shares of DANONE are 3.7% lower than their February high as of March 1.
- The Italian election resulted in a hung parliament with Pier Luigi Bersani’s coalition winning a majority in the lower house but with no party or coalition winning a majority in the upper house. As the days have ticked by since the February 24-25 election, the chance that anybody will be able to put together a government has dwindled. That leaves Italy adrift for at least a month and certainly more—do I hear June?--if the country needs new elections.
- Projections from the World Bank and the International Monetary Fund have said that economies throughout the EuroZone continue to slow and that the growth projections that countries such as Spain, Portugal, and France used to put together their plans to reduce their budget deficits are now not just optimistic but unrealistic. Countries that missed their budget deficit targets in 2012 now look likely to miss them again in 2013.
- The political reaction to the Italian election has served as a vivid reminder that European leaders are locked into a strategy of austerity, austerity, and more austerity. That’s especially problematic now because Italian voters rejected more austerity (and a good bit of past austerity too) in the recent election and because as economic projections go from bleak to bleaker austerity seems more and more like an economic policy that has failed. If, because of their own internal politics—a September 22 election in Germany—leaders of countries such as Germany and the Netherlands remain locked into austerity, then financial markets are about to see a replay of the Greek crisis—but with more chips on the table.
- A budget crisis and the need for a bailout in Cyprus has again raised the specter of a country forced to leave the euro
- And, finally, the Italian crisis has led some in the financial markets to read the fine print in Draghi’s promise of unlimited bond buying. The European Central Bank promise had a big condition: A country had to make a formal request for a ECB bond-buying program to the European Stability Mechanism and agree to the conditions—budget cuts, tax increases, and economic reforms—set by the EuroZone’s bailout fund. Italy currently can’t meet those conditions because it doesn’t have a government that can agree to anything. Spain has refused to make a formal application to the European Stability Mechanism because it doesn't want to give up control over its finances as Greece has had to do. With bond yields falling on Draghi’s promise, Spain has felt comfortable doing nothing. In recent weeks markets have again begun to wonder how long that’s a viable position for the Rajoy government.
Investors will get some clues from Mario Draghi’s press conference following the March 7 meeting of the European Central Bank’s governing council. I doubt the central bank will do anything, which makes what Draghi says and how markets react to his words especially important.
We’re likely to witness a major test of the ability of rhetoric to control the euro debt crisis.
And then its up to the financial markets to react to events—the talks on a Cyprus bailout and the likelihood of continued chaos in Italy—to decide how quickly we move back into a real crisis condition.
Italian 10-year yields have climbed by 0.67 percentage points from January 25 to March 1, but considering that we’re looking at a country without a real chance of putting together a government for a minimum of two months that move in bonds has been very muted. The fall in the euro against the U.S. dollar—4.6% from February 1 to March 1—has been more pronounced, which leads me to think that bond market yields will continue to move higher (which means that bond prices are moving lower.)
But I don’t expect that move toward higher yields—and lower bond prices—will be smooth. Investors have competing financial crises in Tokyo and Washington to watch. The pound sterling is sinking as markets become increasingly convinced that London wants a weaker pound to help its economy. And I expect that Draghi’s rhetoric hasn’t yet lost all its power.
By July I think we could see the euro debt crisis again in full flower—driven by bad first quarter economic reports and another found of mid-year downgrades to projections from the International Monetary Fund, the World Bank, and the Organization for Economic Cooperation and Development.
If that time table is right, I’d expect to see bargains on the stocks of great European companies in July and perhaps sooner as this crisis leads the market down and up and down and up and down again.
What stocks? Here are the ten I’d most like to pick up at a bargain price.
Banco Santander (SAN) because the Spanish bank remains a dominant global bank and some day Spain’s banking troubles won’t weigh down the franchise. (Banco Santander is a member of my Dividend Income portfolio http://jubakpicks.com/ )
Bank Zachodni (BZW.PW in Warsaw) because Poland has been the fastest growing economy in Europe and the longer euro troubles keep Poland on the zloty, the more Poland will thrive as a low-cost manufacturing base for Germany
DANONE (DANOY in New York or BN.FP in Paris) because of the potential of this French dairy producer in emerging markets (and because I think it is sooner or later an acquisition target.)
Dassault Systems (DSY.FP in Paris or DASTY in New York) because this software maker is one of the leaders in software for printers used in 3D manufacturing.
Kone (KNEBV.FH in Helsinki) because this Finnish maker of elevators and escalators is linked to the global construction market via big exports to Asia.
L’Oreal (OR.FP in Paris) because the cosmetics maker is expanding in emerging markets and because when Nestlé’s (NSRGY) stand-still agreement expires in 2014, L’Oreal will either be the target of a takeover or wind up wooing investors as it tries to buy back Nestlé’s shares.
LVMH Moet Hennessy Louis Vuitton (MC.FP in Paris or LVMUY in New York) because this is one of the premier luxury goods companies in the world.
Novo-Nordisk (NOVOB.DC in Copenhagen or NVO in New York) because U.S. FDA delays with Tresiba, the company’s newest insulin, and the euro debt crisis might be the only chance to get the stock at a discount.
Schneider Electric (SU.FP in Paris) because this French maker of electrical equipment is a great way to play the global build out in utility grids.
Svenska Handelsbanken (SHBA.SS in Stockholm) because this very conservative Swedish Bank will take a hit from troubles with the euro for no good reason.
I’d look on the next few months as a chance to decide which of these, if any, fit into your portfolio, then sometime around mid-year you’ll be ready for adding to or beginning positions in these stocks. Look to the lows from 2012 just before Draghi’s “whatever it takes speech” to give you an idea of what might constitute a bargain for these shares.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Bank Zachodni, LVMH Moet Hennessy Louis Vuitton, Novo Nordisk, and Svenska Handelsbanken as of the end of September. For a full list of the stocks in the fund as of the end, of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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