Time of Uncertainty and Cheap Stocks
In this time of instability, volatility and general expectation of a second recession, the attention of all world politicians, economists and investors is drawn to the events taking place in Europe. Specifically, all eyes ware concentrated on Greece.
Two years ago, when a new Prime Minister, George Papandreou, assumed office, the worrisome sovereign debt intensified the global financial situation. Furthermore, the contagion started spreading around Europe and affecting global markets.
As the market started to trade purely on fear and feed daily on the news from Europe, global leaders held two summits this past month. The G7 summit brought success and hope for a crisis resolution (50% write-downs of Greece debt, recapitalization of banks and leveraging of the rescue fund to €1 trillion). It reflected positively on the market globally as most markets rallied back for the rest of the week after the summit. However, the second summit of the world’s top 20 leaders, which took place on November 3rd and 4th in Cannes, France, ended without an agreement on how to support Europe’s indebted nations.
Yet another challenge hindered the world’s investors as the Greek Prime Minister announced that a referendum would be held to decide on the acceptance of the newly proposed bailout package. It is clear that putting such a decision in the public’s hands could jeopardize not only the fate of Greece itself, but also the world’s markets as a whole. When the European Union and IMF are lending such enormous amounts in rescue efforts, they need to be sure that drastic measures are undertaken in the country for the assurance of future paybacks.
Understandably, after two years of fiscal regulation in Greece, the nation is exhausted and unwilling to take further cuts in wages, increases in taxes, decreases in government spending and increases in the retirement age.
Shortly after Papandreou’s statement about the referendum, two leaders from France and Germany, the two main lenders to Greece, presented the borrower with an ultimatum to remain in the Union. Despite the prime minister’s desire for pure democracy, the referendum was abandoned.
Following the G20 summit, to Papandreou’s relief, the parliament put trust in the current government and the prime minister gained the vote of confidence. The committee is being organized and most likely to be led by Greek Minister of Finance Evangelos Venizelos, who will secure the approval of the bailout deal. In case of disagreements, Greece will not receive a penny and run out of money shortly in December.
The situation is still not positive. The possibility of systemic risk is present as the entire world is interconnected. The failure of Greece would lead to the spread of contagion in Europe. Italy, for example, is at risk, even as the second largest bond market with an A rating. All the European countries may undergo a ratings downgrade due to the drastic changes in the environment and high interest rates will put an additional burden on the existing sovereign debt.
As mentioned earlier, the markets are primarily driven by fear from Europe and fundamentals have been forgotten. Yes, the fear is well-grounded; United States exposure to EU is present. The obvious candidates for any contagion from Europe are American banks. As a matter of fact, S&P Financial Sector is down by 13.5 percent year-to-date and was down by 27 percent in the beginning of October.
Another threat for internationally operating companies in S&P is a stronger dollar. The sharp rise in the currency during the third quarter has influenced results, with Alcoa, Harley-Davidson and IBM adversely affected. The United States dollar appreciation is in direct correlation with the decline of the economy. The great uncertainty of the economy is seen on the volatility index (NYSE: VIXY), which remains high from this year’s low in July by 114.71 percent.
So far in the quarterly reposts, companies show strong income and revenue increases beating analyst estimates. For reasons mentioned above, however, the markets are trading cheap versus the outlook for company profits. This signals that long-term investors could be tempted to look for bargains if they believe what they are hearing from companies and analysts. Based on a historic multiple of 15 times earnings, the S&P should be much higher at about 1,500 (versus the current 1140–1253 range for the past month), argue investors.
The employment situation has improved and continued to trend up in October (+80,000), and the unemployment rate was little moved to 9.0 percent, the United States Bureau of Labor Statistics reported. Moreover, the bureau reported on November 5th that third-quarter business sector labor productivity increased by 3.1 percent, with output and hours worked rising 3.8 percent and 0.6 percent, respectively.
The uncertainty will continue sending waves into the stock market. The risk of the European zone situation hovers over the world by sending stocks down, disregarding the fundamentals of underlying companies. The opportunity is present for long-term investments, but be smart in your decisions. Always remember the words of Warren Buffett: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down” and “Risk comes from not knowing what you’re doing.”
— Nikolay Mal’tsev