Monday, November 29, 2010

Life goes on in Europe despite all the bad news


With all the hand-wringing in recent days over the ramifications of the Irish bailout and the continued struggle of the other PIGS to avoid default, I thought this chart might have a calming effect. To the extent that the DAX index of German stocks is representative of conditions in general in Europe, what it shows is that Europe is in fact in better shape than the U.S. German stocks, priced in dollars, have modestly outperformed U.S. stocks since the end of the recession, and over the past 15 years. You wouldn't guess it from the hand-wringing headlines, but today the DAX is only 2.7% below its recent, post-recession high. European stocks underperformed noticeably in the late 90s and early 00s, but that was mainly due to a sharp and pronounced depreciation of the euro, which hit a low of 0.827 against the dollar (37% below its value today) in late 2000 and was very weak through 2002.


As the chart above shows, 2-yr Euro swap spreads are elevated, but that merely confirms that European markets are nervous about what is going on. Swap spreads aren't nearly high enough, however, to suggest that there is a serious level of systemic risk or fundamental lack of liquidity in Europe. Defaults and bailouts are not pleasant, but they aren't life-threatening, at least at the present time. As long as markets remain liquid, factories keep operating, and folks continue to show up for work, the European economies should continue to plod ahead, albeit rather slowly, as is the case here in the U.S.

11 comments:

Bill said...

Scott,

Is there anything Europe can do to stablize this mess in the short term or do you think it's going to hang over the markets for at least a few more years until the debt is either restructured or these economies grow enough so it doesn't matter?

Family Man said...

As the name of the game is the open economic zone from Gibraltar to Wladiwostok (as current RU/GE statements tell us ) one can hardly imagine that GE/FR give up EUR/EU project. As dust settles we see more pro growth/less social EU.

And another very good data - the world biggest cargo hub - "Hactl sets peak records in October"
http://www.hactl.com/en/mediactr/press20101102.htm

Scott Grannis said...

Debt defaults, if the occur, needn't mean a deteriorating economy. They are better thought of as wealth transfers. They are painful, but if they don't result in a shutting down of activity—and consider that those on the losing end of the transfer are unlikely to work less as a result—then life goes on. And if the mess results in a trimming of the size of the public sector (quite likely), then that is a boost to growth as well. In the end, the best solution is growth, and as FM points out, Europe is moving in a pro-growth direction with fiscal policy.

Frozen in the North said...

Hold on Scott, first the German manufacturing powerhouse is doing great, especially with a a weaker Euro, secondly, its financial institutions just got a boost for their Irish exposure, since the ECB has just agreed to make them whole.

Of course one wonders when the penny will drop, since Germany exports mostly to other European countries: Especially Greece, Portugal and Spain.

Public Library said...

Germany is not the barometer of Europe. It is the barometer of Germany.

The global game of kick the can and beggar-thy-neighbor continues another day.

And once again people are trying to solve insolvency issues with more paper money.

Nothing has changed in over 2 years. Don't be surprised of more repeat performances in the future.

Dr William J McKibbin said...
This comment has been removed by the author.
Dr William J McKibbin said...

Most of Europe's debt involves transfers from the private sector to the public sector. In other words, the private sector will come out of this disaster in better rather than worse shape. Conversely, the public will be saddled with vast sums of national debt that will never be repaid. To understand how and why the public sector will be ruinous, watch this humorous video:

Those Europeans...

I continue to urge the public to prepare for inflation by moving aggressively into high quality dividend and rent paying equities, and to abandon bonds of all types. Forget gold by the way as governments will likely seize gold holdings as they did during the 1930's. If you are still in the workforce, start adding hard skills to your resume (experience alone is not going to be enough). If you are on a publicly funded pension and have no other sources of income, get ready to reduce your lifestyle as inflation causes real reductions in public stipends under inflation (the cost-of-living increases will signficantly lag inflation). I might also add that those working in the public sector (with the exception perhaps of law enforcement and the court system) should seek to find alternative employment in the private sector sooner than later. The future will be about private enterprise, while the public sector collapses under the weight of public debt defaults around the world (including the US). Those with real wealth or accredited skills will be the winners in the coming inflation, while those who are dependent on the public sector or who lack hard skills will experience declining standards of living. Be smart and prepare for inflation by becoming a compleat capitalist in society.

Earlier today, Pres Obama (a liberal Democrat) requested that Federal wages be frozen for the next two years -- the Republicans will no doubt be more than willing to freeze Federal wages indefinitely -- such a request from a Democratic President speaks volumes about the direction our nation will take in the coming years. Get ready for inflation...

Dr William J McKibbin said...

Most of Europe's debt involves transfers from the private sector to the public sector. In other words, the private sector will come out of this disaster in better rather than worse shape. Conversely, the public will be saddled with vast sums of national debt that will never be repaid. To understand how and why the public sector will be ruinous, watch this humorous video:

Those Europeans...

I continue to urge the public to prepare for inflation by moving aggressively into high quality dividend and rent paying equities, and to abandon bonds of all types. Forget gold by the way as governments will likely seize gold holdings as they did during the 1930's. If you are still in the workforce, start adding hard skills to your resume (experience alone is not going to be enough). If you are on a publicly funded pension and have no other sources of income, get ready to reduce your lifestyle as inflation causes real reductions in public stipends under inflation (the cost-of-living increases will signficantly lag inflation). I might also add that those working in the public sector (with the exception perhaps of law enforcement and the court system) should seek to find alternative employment in the private sector sooner than later. The future will be about private enterprise, while the public sector collapses under the weight of public debt defaults around the world (including the US). Those with real wealth or accredited skills will be the winners in the coming inflation, while those who are dependent on the public sector or who lack hard skills will experience declining standards of living. Be smart and prepare for inflation by becoming a compleat capitalist in society.

Earlier today, Pres Obama (a liberal Democrat) requested that Federal wages be frozen for the next two years -- the Republicans will no doubt be more than willing to freeze Federal wages indefinitely -- such a request from a Democratic President speaks volumes about the direction our nation will take in the coming years. Get ready for inflation...

Pragmatic said...

Many mistakes in this post.

1. DAX is not the barometer of Europe. SX5P and SX5E are both better indexes.

2. It doesn't make sense to value an European index in USD to judge its performance.

3. DAX is a total return index while the SPX series you are showing is price only. You are comparing apple with orange. If you include dividends, SPX has higher total returns than DAX in USD terms.

Scott Grannis said...

Pragmatic: Thanks for the comment. I would argue, however, that the only way to compare the behavior of two investments is to use a common currency, preferably the currency of the one doing the comparing. Otherwise you are truly comparing apples to oranges (or dollars to euros, in this case). I should have realized that the DAX is a total return index (I learn something new every day), but I note that since 12/31/94, the total return (in dollars, including dividends) of the DAX is 8.14% annualized, whereas the S&P 500 is 8.11%. Virtually identical. The S&P 500 has handily outperformed the SX5E and SX5P indices in dollars, however, by almost 3% per year.

Steve Fulton said...

It seems to me that anything that gets Europe closer to tossing off the Euro is very bullish. Especially for Europe. Now if we could get the rating agencies to downgrade the US we would have two incredibly bullish events at once.