Monday, May 17, 2010

Where's the angst?

Given the plunge in the euro and the rampant speculation that the euro is history and its coming dissolution will prove very painful for the Eurozone economy, you would think that German equities, measured in dollars, would be in free-fall. But you would be wrong, as this chart shows.

Note that the two y-axes on the chart are scaled to be identical—the high point on each axis is 5 times the low point. One thing this reminds us of is that equities have rallied by a factor of almost 3 in the past 15 years. Not too shabby: the S&P 500 index has risen a little over 6% per year, compounded, since the end of 1994. Measured in dollars, Germany's DAX index has risen about 7% per year. So much for the collapse of Europe and the demise of equities.

The chart also illustrates how closely the equity markets of the U.S. and Europe have tracked each other over the years. Most of the variations shown in the chart are due to currency fluctuations, but these tend to wash out over time. In fact, the DM today is about 5% stronger than it was at the end of 1994. So the almost 20% decline in the euro since its Nov. '09 high against the dollar was not so much a collapse as it was a reversion to mean. Just keeping things in perspective.


Benjamin Cole said...

If I read this chart correctly, the DAX index, measured in dollars, more than quadrupled from 2003 to 2008, then was roughly cut in half, before recovering of late.

Holy Moly!

One might forgive German investors for feeling that perhaps bonds or property make sense.

Retirement planning, anyone?

Public Library said...

You can only contaminate so many sovereign balance sheets before the game of hot potato ends.

If Germany was smart they would bail from the EU sooner rather than later. The structure was designed for the great moderation, not the sovereign default era.

John said...


I have read that the bid/ask spread on the bulk sale of residential real estate assets is converging rapidly in Californis. This is leading to price discovery for large portions of banks' balance sheets. I understand the market is still not quite liquid but that competition too buy these blocks is increasing.

If you run across more details of this I would appreciate knowing about it. I think this is pretty good news for the banks.

John said...


FWIW, Stratfor is predicting that Germany will remake the Eurozone largely on their terms. For now, that appears to be their plan for better or worse. A lot can still go wrong...Germany's public may change their government, there may be significant resistance among other euromembers to Germany's 'rules', and many others. But for now, the situation has been stabilized and there will be no restructurings or defaults in the short term. Italy priced and sold bonds last week so things are slowly calming down.

Europe has many long term problems and it remains to be seen if they can or will solve them. But for now, the immediate crisis IMO has passed.

Scott Grannis said...

Benjamin: the book "Panic" that I mentioned the other day helps to explain and understand the extreme volatility in equity prices in recent years. One of the book's key insights is that the market has come to accept the theory that markets are efficient. In fact, markets are not efficient, and thus there can be wild swings in valuations that may or may not have anything to do with the underlying fundamentals. One lesson I'm learning from all this is that big swings in market prices therefore do not imply big swings in fundamentals. They imply simply that the market is not working very efficiently. Consequently this creates huge opportunities for investors who can correctly focus on the underlying fundamentals. In other words, selloffs such as we have seen recently become buying opportunities.

Benjamin Cole said...


Can't wait to read the book.

I am building up a pile for some long airflights to Thailand.

Ironically, a friend also recommended I read a book entitled "Panic" -- the book by Michael Lewis, on roughly the same topic (Lewis is famed for writing "Liar's Poker"). Panic is everywhere.

I have an unformed, amateur idea that the large slugs of capital rolling around capital markets now flood into "hot categories." The rise of ETFs and increasingly special mutual funds means that when an asset becomes hot, investors can pour money into such ETFs and funds, creating a self-fulfilling prophesy. The program trading probably adds a filip. Private equity funds are huge now too.

I have even toyed around with "momentum investing" by investing, with weekly updates and some other criteria, in the five best-performing ETF funds of preceding four weeks. (This is easily done by using websites than rank ETFs). This seems to work.

It goes against my grain--there is little fundamental research, and you just buy winners and ride them for a week--but results are good.

I suspect capital flows into a "good idea" for several weeks or months longer than it should.

None of this conflicts with what you just wrote, in fact it fits hand in glove.

I do worry that ordinary investors will get spooked by the volatility. Sheesh, maybe I get spooked by it.

狂猪 said...


I am very optimistic on Europe and on Spain in particular. Here are my reasoning. What do you think?

To start with the main problem of Greece is fear of contagion. The Greek economy itself is too small to matter. The main risk are from the foreign banks holding Greek government bonds. Will Greece default? With the recent aid packages, sovereign default does not make economic senses in the near term. If Greece defaults now, it will immediately have to make a hard stop on all government expenditures that are financed by debt. Whereas with the recent $145bn aid, Greece has 3+ years to more gradually adjust it's fiscal situation. The 3 year adjustment will still be painful but it should be a lot less painful than a full hard stop.

Note that Greece may want to default 3 years from now. At that point, hopefully it will have tighten government spending so as not to need new debt financing. Furthermore, its debt would have grown. At that point it could choose strategic default without worrying about being shut out of the debt market. A default 3 years from now makes economic sense from Greece's perspective.

Without a near term Greek default, there is very little near term contagion risk. 3 years from now, I'd bet the world and Europe will be whole lot healthier than today.

Will Europe's new fiscal austerity lead to a double dip recession? The following is a summary of the new austerity programs. Most European nations, especially the big ones, are not taking on serious austerity programs. The total amount from the nations with new austerity measures is tiny compare to the Eurozone's GDP. Here is a summary:

From the numbers, a double dip in Europe due to these new austerity programs is unlikely.

Will the euro and eurozone disintegrate? Let's look at the debt level of eurozone with the US.

Public debt as % of GDP for 2010
Eurozone ~84%
US 98%

Fiscal deficit as percent of GDP:
Eurozone 6.9
US 12%

This would suggest eurozone's debt level and spending level are both healthier than the US. Although the US is growing (recovering) faster from the recession. The concern over the euro because of public debt level is overdone.

The reasons I like Spain are:

1. Spain was unfairly grouped with Greece. Prior to the current crisis, Spain had a good government and low level of public debt (today ~66% of gdp). It ran up a big fiscal deficit last few year to lessen the economic crisis.

2. Spanish equity are cheap. For example the EWP etf has a p/e of less than 11 and a dividend yield of over 5%.

3. Spain is benefiting from a cheap euro and growing export surprisingly more so than Germany.
Please see the chart at

Scott Grannis said...

狂猪: I think there is widespread confusion over the economic impact of a return to fiscal austerity. Most people seem to believe that fiscal "stimulus" policies, which involve spending borrowed money, can give the economy a boost. Therefore they worry that reversing these policies (i.e., cutting spending) will be bad for the economy.

My position is different: I don't believe that government can use deficit spending to boost the economy. You can't take money from one person (via the bond market) and give it to another and create a bigger or stronger economy. Only the private sector can grow the economy. Indeed, traditional fiscal "pump priming" does not help an economy, it probably acts to slow growth by creating perverse incentives and reducing the economy's overall efficiency.

Therefore, cutting spending does not shrink the economy. It allows the private sector to keep and control more of its money, and since the private sector is more efficient in its use of money, this actually helps to strengthen the economy.

Instead of worrying that we can't cut spending because that would weaken the economy, we should be thinking that cutting spending is a great way to strengthen the economy.

狂猪 said...

Hi Scott,

My view on government stimulus spending is part of a larger view I have on counter cyclical positioning.

I think fiscal policy, monetary policy, and regulatory policy should all be counter cyclical. During the normal times, all three of these should be tightened. This way, during the bad times there is dry powder such that all three can be and should be loosened. Most of the time, the economy moves along steadily. However, every seven years or so, we get into a recession. In that regard, during normal times which is most of the time, I share your view on tight fiscal policy.

I know in practice, the incentives of politicians are such that things don't work out as I'd like. During normal times, our government over spends. During recession, our government spends even more by running much larger deficits. Furthermore, a lot of spending are simply wasteful pork. There is no way to defend the inefficiency of government spending. However, at the bottom of a deep recession, I think stimulus spending may still be net positive for the society. Furthermore, stimulus spending are often investments in the country's infrastructures. Many of these investments (e.g. roads, schools, etc.) have to happen over time anyway. Investing at a market bottom tends to generate higher return and can mitigate some of the inefficiencies.

Scott Grannis said...

狂猪: I just can't share your view that fiscal policy can be stimulative. I'm not a Keynesian, and I don't find any logic in the Keynesian belief that government spending can be stimulative. In my experience, I have never seen a government official spend money more efficiently and wisely than a person spends his own money. The continued belief in the efficacy of government spending as a stimulus to the economy is a tragedy that has afflicted the world.