Don’t worry about what Draghi does today – Europe is still a buy

People are expecting big things from Mario Draghi. But whatever he does, it should have very little impact on your investments, says John Stepek. Here’s why.


Draghi: needs a crisis

Everyone's hoping for great things from Mario Draghi, boss of the European Central Bank, today.

They expect negative interest rates at a bare minimum. But not just that. They're hoping for some sort of more aggressive stimulus' package. Maybe even big-time money-printing proper quantitative easing.

Chances are they're going to be disappointed.

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But the good news is that unless you're betting on the direction of the euro which for most people, including half of London's hedge funds, is proving a very effective way to burn money it doesn't really matter.

Here's why I'd stick with your European stock market investments regardless of whatever stunt Draghi pulls today.

Mario Draghi the best poker player in central banking

I have no more insight into Mario Draghi's mind than anyone else in the world.

But from observing his actions so far, he's the central banker I'd least like to face across a poker table. He's very good at bluffing, even when he has an atrocious hand of cards.

And it's a good thing too. Because holding the eurozone together is one giant game of bluff.

Think about it. This guy has the toughest job in central banking on the planet. Most central bankers are pulling in exactly the same direction as their governments. They all want cheap credit and money printing, or variations thereof.

But in Europe the one economic region left where at least some countries might just benefit from a dash of stimulus' the biggest government considers money-printing to be verboten'.

And you have to sympathise with the Germans. Their stock market is at all-time highs. The economy is healthy. By their standards, they even have a property boom perhaps even a bubble in some areas.

Yes, maybe the Italians and the Greeks could do with a weaker euro, or some help in propping up their economies. But why agree to that, at the expense of potentially crashing the German economy?

So what does that leave Draghi with? Not a lot.

If Draghi wants to have much impact, he has to act big. He has to show the market that he really does have the ability to do "whatever it takes" to save the eurozone. Anything less than shock and awe' won't do.

And the economic data has certainly been weak enough in recent days for him to argue that major stimulus is needed.

But history shows that the eurozone does not act big unless it's facing a crisis. That's understandable. Getting all of those heads of government to agree on a single course of action when they all have different individual goals is never going to be easy. They'll only do it when they are staring into the abyss otherwise.

And that's just not the case right now. So far the peripheral' countries are sucking up austerity nicely. None has had the guts to play their own trump cards a genuine threat to leave the eurozone.

Yeah, the eurosceptics won a few more seats in Europe during the recent elections. So what?

I suspect that the reaction of the euro elites runs along the lines of: "Who cares? That's not where the power sits. Let the voters have their tantrums. Most of the MEPs are just turning up to claim their expenses anyway."

In short, Draghi needs a crisis to give him the excuse to act big. He doesn't have that right now. That's why I suspect that whatever he does today, it'll be underwhelming.

The unintended consequences of negative interest rates

Now I could well be wrong. I certainly wouldn't be betting on the outcome in the currency markets and I think you'd have to be mad or foolhardy to do so.

And I'm not saying he'll do nothing at all that's possible, but it would send the euro a lot higher, which is not what Draghi wants.

The real problem is that the market already expects a lot of him. For a start, it's convinced that he'll at least introduce some form of negative interest rate. This is a pretty radical act in itself, but one that's fraught with potential for unintended consequences.

The basic idea is to charge banks for holding money with the ECB. The hope is that this will encourage them to lend it out. Or at least swap their euros for another currency, which might help weaken the exchange rate.

But it might have no impact at all. Banks might just recycle money into eurozone government bonds. That'll lower those countries' borrowing costs, but that's not really a big help now when they're back at pre-crisis levels anyway. And negative interest rates won't do much for the confidence of the eurozone's savers already the German savings banks (as you'd expect) are up in arms at Draghi.

So this may not be the magic wand the market is hoping for.

Eurozone stocks have a way to go yet

But here's the good news for investors. While this is all quite interesting to discuss, none of it really matters in practical terms for your investments.

We've been tipping the likes of Italy, Spain and Greece for a couple of years now. There were two reasons for that. Firstly, their stock markets were dirt cheap. Even if they'd left the eurozone, chances were that a good number of the companies on those markets would still be worth more than they were priced at.

Secondly, Draghi stopped the crisis in its tracks. As soon as he removed the immediate risk of those countries leaving the eurozone, the rest of the market realised that they were worth buying.

Neither of those things has really changed since. Yes, the peripheral markets have shot up a lot. They're no longer screaming bargains, and we may be moving from the recovery phase to a less exciting period. But I wouldn't sell at this point in historical terms, these markets are still cheap.

And secondly, Draghi still has the confidence of the markets. Even if he disappoints today, the eurozone is a long way from imminent implosion. And I suspect that before we ever get back to that point, he would be capable of driving through the sorts of policies needed to prevent it.

In short don't worry about what Draghi does today. Stick with your eurozone stocks they've a way to go yet.

And if you're looking for markets that are more on the exciting' side, Jonathan Compton wrote a piece for last week's MoneyWeek magazine on investing in cheap, corrupt regimes that show signs of improvement. It's a good read with plenty of interesting if risky tips. If you're not already a subscriber, get hold of the piece and get your first four issues free simply by clicking here.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.