There’s a Reason It’s Cheap

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

A few years ago when I was down the shore in New Jersey with my family, I decided it was time for my then nine- and six-year-old children to try one of my favorite childhood pastimes—boogie boarding. For those unfamiliar, a boogie board is a (very) poor-man’s version of a surf board; basically a short board that helps you ride waves either on your stomach or, if you’re really good, your knees. So we went to the store to buy a pair of boards and found a pretty wide price range— $10 for the 26-inch, all-foam board to $100+ for the 42-inch poly-something-or-other board with the hard-slick bottom. Being a bit of a value investor, and not knowing how much the kids would like riding waves, I went with something much closer to the bottom end of that range. To make a long story short, three hours later I found myself with a broken board (who knew a foam board couldn’t handle a 200+ lb dad demonstrating?), a broken ego, and a trip back to the store to purchase a new pair of boards—this time closer to the middle of the price range. A good lesson for the kids, but definitely a reinforced lesson for me, is often when something is cheap there’s a very good reason why.

8.22.13_Raupp_Cheap_1I’m reminded of this lesson when I look at global equity valuations, particularly those in Europe. Forward P/E ratios (stock price divided by the next 12 months of projected earnings) in most of the major Eurozone countries fall in the 10- to 12-times range, which is relatively cheap from a historical perspective. Compared to the U.S. at 14½ and other developed countries like Japan and Australia at close to 14, the region seems pretty attractive. Tack onto that that the Eurozone has just emerged from its longest recession ever, and the idea that markets are forward-looking, it would seem like a great opportunity to rotate assets into cheap markets as their economies are improving. And we’re seeing some of that in the third quarter, as the Europe-heavy MSCI EAFE index has outpaced the S&P 500 by about 3% quarter-to-date.

But, similar to low-priced boogie boards, buyers of European equities need to be aware of the risks that come with your “bargain” purchase. This past Tuesday, German finance minister, Wolfgang Schauble, admitted that there would need to be another Greek bailout next year even though they’ve been bailed out twice in the last four years and restructured (defaulted on) 25% of their debt in 2012. All told, about $500 billion has gone to support an economy with a 2013 GDP of about $250 billion, and it hasn’t been enough. And by the way, youth unemployment is approaching 60%, and 2013 has seen multiple protests and strikes over austerity measures.

8.22.13_Raupp_Cheap_2Beyond Greece, Portugal and Ireland are running national debts of over 120% of GDP and could need additional bailout money. Italy is operating with a divided government and a national debt of over 130% of GDP, and the Netherlands and Spain are still on the downward side of the housing bubble. Germany has been Europe’s economic powerhouse and has played an integral role in containing the debt issues on Europe’s southern periphery. But they’ve been grudging financiers, so much so that German chancellor Angela Merkel has gone to great lengths to avoid the topic of additional bailouts ahead of upcoming German elections.

Sometimes that bargain purchase works out. You get the right product on sale or you’re able to buy cheap markets when the negatives have already been baked into the price. But make sure you’re considering all the angles, or you could quickly end up back at the store.

The S&P 500 in 2012

2012 was definitely a better year than it felt, with the S&P gaining over +13.0% on a price basis and +15.9% on a total return basis.

It was a great year to be invested in the global equity markets despite investors pulling out over $139 billion from equity mutual funds. Investors continued to pour into fixed income funds, adding over $300 billion during the year. (Source: ICI) The Barclays Aggregate gained +4.2% in 2012.

Below is a great snapshot of S&P 500 performance in 2012 from Bespoke Investment Group:


Growth Fears Weigh On Shares

Joe Preisser

The rally in global equities, which has carried share prices to heights unreached since 2008, stalled last week as the marketplace struggled to evaluate the current risks facing the world economy.  Stocks listed from Europe to the United States slipped as concerns of a slowdown in global growth were drawn into focus.

The selling arrived in the wake of the release of a dour assessment of the world’s economy by the International Monetary Fund (IMF) last  Monday and accelerated following a disappointing start to corporate earnings season.  Citing potential problems on both sides of the Atlantic, the IMF lowered its projection for the expansion of global growth to 3.3% for this year, and 3.6% for 2013 (Bloomberg News).   The International Monetary Fund specifically highlighted the lingering effects of the European sovereign debt crisis, as well as the political gridlock in the United States, as risks that hold the potential to destabilize global financial markets (New York Times).  In a reflection of the difficulties created by the lack of a substantive policy response by the Spanish Government to the current rash of problems confronting the country, Standard & Poor’s on Wednesday lowered the nation’s sovereign debt rating  two notches to BBB- and downgraded their outlook to negative.

Earnings season saw it’s unofficial start last week as Aluminum manufacturing giant, Alcoa Inc.* reported results for the third quarter, which exceeded analysts’ estimates.  Although the company’s revenue and per-share numbers were better than expected, a drop in their forecast of global demand for the heavily used industrial metal sent its stock price markedly lower last Wednesday.  Following on the heels of Alcoa’s disappointing comments, the engine manufacturer, Cummins Inc. declared that it was lowering its profit projections for the remainder of the year as a result of waning demand (Wall Street Journal).  The outlook for the global economy offered by these two manufacturing behemoths highlights the challenges currently facing investors, as they struggle to weigh the risks of an economic deceleration against the coordinated efforts of several of the world’s most powerful Central Banks to maintain expansion.

*Shown for illustrative purposes only.  This is not a security holding of Brinker Capital.