Investing in Europe was seen as the daring, cavalier contrarian trade earlier this year, ahead of the French election.
Indeed, fund managers in general have seen dabbling in Europe as being daring ever since the Greek crisis broke out.
On more than one occasion since 2010, I’ve had a fund manager proudly tell me that they’ve made a bold bet on a cheap company in Europe, using the same tone that they might use to reveal that they’ve taken out a second mortgage to place a spread bet on a rare earth mining stock operating out of Chernobyl.
They’d then tell me the name of the stock. Invariably, it was Nestle.
In any case, what was once contrarian is now accepted wisdom. And we all know what to do when that happens.
A handy indicator to watch
Buying Europe before Emmanuel Macron managed to confirm his victory in the French election in May was a pretty good bet. (In fact, we suggested you do just that in MoneyWeek magazine in December, when “la panique de Le Pen” was at its height.)
But now it might be getting a little too popular.
I take contrarian indicators with a pinch of salt. None of them are fool-proof, and it’s far too easy to remember the times when they worked and discount all the times when they didn’t.
However, one that I’ve found useful to monitor is the Bank of America Merrill Lynch fund manager survey. This is a monthly survey by the investment bank, in which fund managers indicate where they’ve put their money and how they’re feeling about markets in general.
At the end of the day, what matters most for prices in markets is money flows. If money is piling into a sector, the price will go up. If it’s coming out, the price will go down. Fund managers are the ones with the money. So knowing what they think – however rough and ready – is handy.
What’s interesting now is that bullishness on the eurozone and Europe is at a record high. Global fund managers are heavily “overweight” the eurozone, particularly by comparison to the US.
It’s clear that they’ve taken Macron’s victory as the “all clear”. And so they’ve piled in, partly because US stocks are so expensive and they’re hoping that Europe will close the gap.
However, as BoAML points out, bullishness at this sort of level “is often a contrarian signal”. Put simply – disregarding valuations and the rest of it for a moment – if everyone who wants to buy an asset has already bought it, then there’s no more money available to send the price higher.
And that looks as though it might be the case with the eurozone for now. Don’t get me wrong – I wouldn’t be selling out of or shorting Europe. It’s more that it’s probably time for someone else to have a go at being the hot market. And that suspicion has been confirmed by the market reaction to the European Central Bank’s (ECB) latest press conference.
Draghi’s difficult juggling act
As I’ve mentioned a few times, Mario Draghi, head of the ECB, has always been one of the most skilled central bankers around. He has to be. He is setting monetary policy for a very disparate group of countries, the most powerful of which is rather unusual in that its population doesn’t really approve of or feel comfortable with easy money.
So while the rest of the world’s central bankers just went straight to zero interest rates and rampant money printing (quantitative easing – QE) after the financial crisis, Draghi had to get there by stealth.
He spent most of the Greek crisis, and the years following it, trying to sneak eurozone QE past the Germans. And before he managed to do that, his only real option was to try to push the value of the euro lower. A weak euro represented a bit of a lifeline for the more fragile countries in the eurozone. Not much of one, but every little helps.
Of course, it was also a huge help to the German economy, because a cheap currency means more exports. Germany is an export-heavy economy, and so its stock market has shot up, and meanwhile, loose monetary policy – combined with Berlin’s newfound status as the global spiritual home of the true hipster – means it’s even having something of a housing boom.
Nevertheless, the Germans like their sound money (who can blame them?) and with an election coming up, the ECB needs to keep them happy.
So Draghi now has the problem of trying to make it look as though he’s thinking really hard about reducing the amount of QE that the ECB is doing (they’re still printing €60bn a month), while not actually doing it.
The tricky thing is that the market now has the bit between its teeth. It reckons that Draghi will have to start talking about “tapering” very soon. That means the euro has been shooting up.
The single currency went from being near-parity with the dollar at the start of the year, to above $1.14 at the start of this week. Then, yesterday it surged above $1.16, despite Draghi’s best efforts to dampen expectations.
Once a currency gets that kind of momentum behind it, it can be difficult to get it to change course without doing something drastic. And of course, Draghi probably won’t want to do that until the German election is safely out of the way.
So overall, I’d expect European stocks to stop being flavour of the month for the summer. A better candidate if you’re considering a bit of a rebalancing? There’s a lot of gloom around on the UK, but I feel that’s probably yet to peak.
Japan might be a better option – when there are lots of bulls around but they can’t quite get excited about valuations anywhere else, Japan tends to get its turn at the front of the queue. And global fund managers are neither overly bullish nor overly bearish on it right now.