If one were to look exclusively at the main European stock indexes, for the past year, one would think we are looking at a booming continent. The German DAX is up about 18% over year ago levels, France's CAC 40 is up 17%, and the FTSE 100 is up about 11%. Not bad for a continent where for the past few years already, a return to sustained growth seemed always just a few quarters away, but it seemed we never got there. Now, we finally have some positive numbers for Q2. Quarter on quarter growth was 0.3% for the Euro zone as well as for the EU as a whole.
So why was the EU stock market doing so well, while the economy was not? The answer is simple: Many of the companies traded are in fact relatively well-performing multinationals, which no longer rely on EU economic fundamentals for the bulk of their bottom-line forming business, especially when it comes to sales. Compared to same time last year, for the first half of 3013, EU exports are up 5%, while imports are down 6% according to Eurostat data. It is precisely this differentiation, which we should keep an eye on when looking to invest, in anticipation of a pickup in economic activity in the EU.
It is important to realize that many companies in Europe, which still depend on local demand for their sales, will have to wait a while longer to see an improvement in consumer demand. Car manufacturers, such as, Fiat or Peugeot will continue to see weak demand for their products in the months and even perhaps years ahead, even though current establishment consensus indicates that car sales should start picking up across Europe next year. Other companies, which are highly dependent on regional consumption such as retailer Carrefour SA will not necessarily feel the effects of the end of the recession either, until perhaps some time next year.
Youth unemployment, which has reached crisis figures of as much as 50% in some countries, such as Spain and Greece, means that the traditionally vibrant consumer demographic is unlikely to start spending any time soon on cars or other products deemed, nice to have, but not absolutely necessary. Even after youth unemployment will start declining, there should be a lag-period from the time they start earning money, to the point when they become active consumers of non-essential goods and services. First, will come the effort to start improving their personal balance sheets, and only once that starts improving, can we expect them to consume more. Current unemployment in the European Union is at 10.9%, while the Euro zone is at a record 12.2%, and is actually forecast to continue rising for the rest of the year, despite the end of the recession.
What to look for when investing in Europe?
In my opinion, companies reliant on international demand have very little potential upside left, given that the global economic environment is not improving all that much. In fact, there has been cause for concern with developing markets showing signs of slowing growth. On the other hand, EU exiting the recession should mean that domestic demand should start supporting company earnings growth. This is true, but I believe it would be wise to remain somewhat conservative and wait before investing heavily, until there are clear signs of sustained job growth.
If one is looking to get ahead of the market, it helps to find companies with potential to be market leaders. One such company in my opinion is Renault S.A. It is well positioned to provide affordable cars for the European market, through its Dacia brand. For instance, the Dacia Logan is available for around € 8,000 ($10,500). They could potentially go even lower in price, given their recent opening of a factory in Morocco, where labor costs are only half of what they are paying their Romanian Dacia employees. Romanians are already the worst paid workers in the European Union, so Renault is definitely looking good to compete in the low-cost segment of the EU car market. My guess is that they will continue expanding production in Morocco, if all will be well in terms of quality. While EU car sales are down slightly (-6.7%) in the first half of 2013, compared to same period last year, Dacia sales are up 16.5% (for more info). This is something that Renault can build on.
Daimler is also a company worth looking at in my view. It opened a new Mercedes passenger car factory in Hungary last year, where production is just ramping up, with potential to expand the site. Lower labor costs in Hungary are saving them about 30% on overall manufacturing costs, compared to their German operations, according to their production chief Wolfgang Bernard. If they will continue to expand their Hungary operations (currently geared towards foreign markets), Mercedes could become highly competitive on the European passenger vehicle market scene, with Hungary offering not only lower wages compared to Western Europe but also comparatively better transport infrastructure and a better-educated workforce, compared to other countries, such as Romania. Combined low-cost production, with prestigious brand name, as well as a stock price that has been suffering in the past years (Daimler shares are up about 15% in past five years compared to main rival BMW stock, which is up 150%). I think Daimler is now ready to take the fight to BMW in Europe, which unlike Daimler, does not have an established production line in Eastern Europe, where production costs are much cheaper.
Looking for opportunities in currencies:
For the average investor, it is unfortunately hard to access international stock markets. There are some companies offering international trading accounts, with only limited choices. There are ETF's which can help investors gain exposure to the broader global market, but with ETF's one does not necessarily get a chance to take advantage of specific opportunities. Hungary is a good example of this, where the BUX index is up about 5% year to date, despite the fact that its economy is likely to outperform this year's EU 27 growth average, forecast by the ECB to be at -0.1%, compared to +0.2 for Hungary, according to Eurostat. One can find Hungarian stocks within the SPDR S&P Emerging Europe ETF, alongside Poland, Russia, Turkey. Kazakhstan and the Czech Republic, but care should be taken to observe the fact that this ETF as well as others will not be impacted heavily by the performance of the BUX. Hungarian stocks within the ETF are very international, and they are just a small component of the ETF, which is heavily dominated by Russian energy companies. Therefore, if one were to want to bet on a BUX out-performance, based on signs that some of the main problems in Hungary, such as the FX debt situation are being gradually un-wound, it would be hard to do so.
In the absence of going through the effort of opening an account specifically to allow one to take advantage of such opportunities, the only way to gain exposure is by looking at trading currencies. I believe some East European members of the EU have the potential to out-perform the Euro zone in terms of economic growth as well as in firming of their currencies. Aside from obvious contenders such as Poland and the Czech Republic, I think people need to keep a close eye on Hungary. Aside from the piles of government and private FX debt and the high-deficit, low-growth economy left by the previous Socialist government, which was already in deep trouble, even before the 2008 crisis hit, there has been a lot of ill will and hostility on behalf of major institutions, including the IMF, rating agencies, as well as segments of EU political establishment, especially on the left. This has had the effect of creating a bad image for the country, which has affected its economy negatively. I believe many of these problems will be gone next year. Hungary survived the crisis without the IMF, despite the prophecies of doom. They have been working hard to resolve the FX debt issues, and it seems a solution agreeable to all, including the banks is within reach. This might relieve the burden on hundreds of thousands of households, setting the stage for a revival in domestic demand. At the same time, with the EU revival upon us, exports will likely pick up. The budget deficit was only 2.1% of GDP last year, which was one of the best levels among the EU 27 members, and it will likely stay under 3% for this year and next as well. Most importantly, national elections will be held next year, and with that, the EU Socialists will likely settle down, regardless of the results. I think this all adds up to a potential for an economic pickup by the end of 2014. I think this is one story that has potential, because of all the negativity surrounding this country, much of which is ideological rather than rational, which has kept its currency depressed. If I am right, there will most likely be a decent rally in the Hungarian Forint, starting sometimes next year.
With an end to the long recession in Europe, I think we are about to embark on the journey of what we will later refer to as the cyclical good years for the global economy, following the 2008 crisis. I have no idea how long this will last. Perhaps it will last for the rest of the decade, but I doubt it. Given that these "good years" will not be years of robust growth we came to be accustomed to in previous cycles, we should expect the bulk of stock market gains to have been made already from the 2009 lows. There are a few opportunities around the world, including in Europe, where some markets and companies had a lackluster performance, due to various factors, but have the potential to catch up to the herd. A few companies, such as Renault SA, have many things going for them, which could establish them as pack leaders in an otherwise slow moving pack. The end of the EU recession in my view signals the start of the time when people need to be extra selective and vigilant in their choices. There are many opportunities, but also many ways to miss them by not investing selectively and prudently.