The headlines these days scream of impending doom in the EU. The Euro is falling, European stock markets are falling, Germany is banning naked short selling etc. All these fears have taken a heavy toll on stock prices. To the extent that these events reveal an underlying lack of confidence in the EU, something that can unravel a financial system all by itself, the falling share prices reflect some truth. However, besides confidence, the fundamental indicators emanating from Europe—the falling Euro, ECB actions, debt auctions and fiscal reform—indicate growing strength and an increased likelihood that this crisis will be resolved without major fundamental damage. More importantly for me as an investor, once fickle moods change and investors see that the fundamentals are not nearly as bad as they currently seem, stock prices should come roaring back.
The falling Euro should be viewed as a boon. Devaluing currency in the face of large debts has historically been a relatively non-disruptive way for countries to ease their debt burdens without the shock of a default or the recession that can come with sudden austerity. So long as inflation doesn't get out of control, debt levels are reduced without the significant monetary tightening that causes losses of output and unemployment. It also provides a mechanism for recovery by making exports more competitive. This situation is no different: the falling Euro will help with the EU wide problem of high costs vs. emerging markets and will increase exports. This will bring in foreign exchange of increased value and make real debt levels drop. Some argue that the falling Euro will not help peripheral economies since they mainly trade with each other. More than ever, though, what is good for Germany becomes good for the entire EU, especially with the new bailout package. Export driven economic growth in Germany will ease political pressure against bailouts. It will make it easier for Germany to borrow without running up large debt/gdp stocks. This will make it easier for Germany to lend to peripheral economies even if private markets won't.
Similarly, the ECB's decision to monetize debt will not weaken the EU as some claim. Inflation in the face of high debts, like devaluation, is the least bad way to handle unbearably high debt stocks. Monetizing debt will keep capital markets running relatively smoothly in the face of fickle private demand. The resulting inflation will decrease debt in real terms and will aid the fall of the Euro, further driving competitiveness increases and exports.
Finally, the weakest peripheral governments of Portugal, Ireland, Greece, and Spain have announced austerity measures. This too has been presented as mainly a bad thing for the global economy in my recent readings. However, assuming that these austerity measures are carried off successfully, then, given that these countries mostly trade with themselves the negative impact on global demand and thus the global economy will be minimal (their combined GDP is ~2.25 trillion, assuming a drop of 10%, that's 225 billion of fallen demand; compare that with China's expected growth rate of 10%, adding 490 billion of GDP). On the other hand, the benefit of restored confidence that successful austerity will bring to financial markets will more than outweigh the dip in demand. I certainly acknowledge that austerity will slow economic growth adding further to the pain and unpopularity of the measures. If, down the line, this causes countries to consider default as an alternative, there is reason to fear. However, I believe the day when that starts to become a real concern is at least couple years from now. There's no reason for Portugal, Ireland, Greece and Spain to give up on the austerity measures they've already spent the political capital pushing through without at least giving them a try.
These improving and beneficial fundamentals show that lack of confidence is ungrounded. Furthermore, regarding this lack of confidence, it's not even clear that it extends beyond stock markets. After all, European bond markets seem to be flowing fairly well. According to the Financial Times, Portugal, Spain, France and Germany all just completed debt auctions with greater than 2 times bid coverage. Spain and Portugal received rates only slightly higher than historical averages and in Germany rates were at their lowest since 1998. Yes, rates are low in Germany right now because of its haven status, but with the bail out cheap German bunds assist cheap financing for other EU countries. I'll concede that well covered debt auctions aren't as indicative of investor confidence now that the ECB is a buyer. Still, even under the worst case scenario where the ECB were the only buyer of debt the resulting devaluation would aid economic growth and ease debt burdens.
Thus, in my mind, the fundamentals are sound in the EU. No default is coming and there is a path leading to financial stability and sustainability. Right now stock markets are caught up mainly in their own momentum, something that has happened time and time again. Stocks fall on news of the falling Euro, the Euro falls on news of falling stocks. All fall on news of themselves falling. It's driven by fear and a lack of understanding about the fundamentals. Investors hear news of a ban on naked short selling, a policy whose effects they don't understand. The confusion and the fear of further losses drive them to get out, sit on the sidelines, and wait for the dust to clear. But people are forgetting a very important truth: if the fundamentals haven't changed, a stock that's priced lower today than yesterday isn't a worse value, it's a better value.
Every day I wake up and see my shipping stocks priced lower today than yesterday and the urge to sell grows. It hurts to see that red. But the fact is that every day their price to book values drop, their price to earnings ratios drop, the amount of money they could pay out in dividends increases. They still have their long term charters. Spot rates for shipping are better than ever. The fundamentals are still sound, for shipping and for the EU. Emotion is driving this dip, but emotion is fickle. Hold on: fear will turn into greed soon enough.