Is Europe a Buy?

What’s in Today’s Report:

  • How Powerful Is the Growth to Value Rotation?
  • Is Europe a Buy?

Futures are edging higher in early trade while most international markets rallied on better-than-feared data overnight.

In Europe, the headline to the German ZEW Survey was a slight miss but business expectations rebounded to -2.1 vs. (E) -12.5 as recession fears continued to moderate.

In the U.S., the NFIB Small Business Optimism Index was 102.4 vs. (E) 102.0 another incremental economic positive.

With no economic reports today, focus will be on Trump’s midday speech in NY regarding the trade war. Additionally, there are two Fed speakers: Harker (1:00 p.m. ET) and Kashkari (6:00 p.m. ET).

The trade war is still by far the most important influence on the markets right now so whether Trump is negative or positive in his discussion regarding trade negotiations today will likely decide whether stocks rally or extend yesterday’s pullback this afternoon.

Why Italy’s Budget Matters

What’s in Today’s Report:

  • Italian Political Primer

Futures are modestly higher and European shares stabilized overnight thanks to positive developments in Italy.

News broke overnight that while Italy still plans on a 2.4% budget deficit for 2019, it will reduce that figure by 0.2% in each of the following two years, resulting in 2.0% in 2021.

Italian yields pulled back from multi-year highs and the euro found support, weighing slightly on the dollar overnight which is a slight positive for US markets.

Today, jobs week kicks off with the ADP Employment Report before the bell (E: 179K) and then the ISM Non-Manufacturing Index (E: 58.0) is due out at 10:00 a.m. ET.

Aside from economic data, there are a slew of Fed speakers today: Barkin (8:05 a.m. ET), Harker (12:00 p.m. ET), Brainard (1:00 p.m. ET), Mester (2:15 p.m. ET), Powell (4:00 p.m. ET), and Kaplan after the close (8:00 p.m. ET).

Europe will remain the primary focus today and as long as the overnight progress on the Italian budget plans is not forfeited in morning trade (before the Euro close) then risk on money flows and an easing dollar should support some upward momentum in US stocks today.

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European Central Bank (ECB) Interest Rate Preview, September 6, 2017

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The ECB is expected to signal it will begin to taper its QE program sometime in 2018 at tomorrow’s meeting; however, the details regarding that tapering announcement remain unclear.

Why It Matters: The dollar. The falling dollar, which is down more than 10% year to date, has been an under-appreciated tailwind on the stock market (a weaker dollar boosts exports and corporate profits). If the ECB is more hawkish than expected tomorrow, that will cause a potentially big reversal in the dollar. I say that, because “long euro/short dollar” is a very crowded trade at the moment, and if it reverses, it could be violent.

The reason this meeting will punch above its weight from a market standpoint is because the ECB commentary on tapering will be (correctly) taken as implicit commentary on the strength of the euro.

The market assumes that the ECB is not concerned about current euro strength. If the ECB fails to announce tapering intentions tomorrow, or is very vague about those intentions, the market will infer that the ECB thinks the euro is too high. If that happens, the euro will drop, hard, and the dollar will soar—and that will likely be a headwind on US stocks, and a (big) tailwind on European stocks (so HEDJ will begin to rally again).

Meeting Expectations If: ECB President Draghi confirms, at the press conference, that the ECB Governing Council intends to taper QE in 2018, and that it will reveal details of that plan at a future ECB meeting. So, Draghi announces tapering is coming, but doesn’t give any details.

Dovish If: Draghi does not announce the intention to being tapering QE sometime in 2018. This is a remote possibility, but given the strength in the euro I don’t want to completely rule it out.

Mildly Dovish If: Draghi announces that the ECB intends to taper QE, and that it will announce the details at the December meeting, at earliest. Draghi likely won’t single out December, but he won’t say details will be revealed at the “next” meeting, which would be October.

Hawkish If: Draghi announces that the ECB intends to taper QE, and says the details of the taper will be revealed at the “next” meeting. That’s the key phrase to watch for. If that’s the case, look for the euro to modestly rally as there is not clear consensus on an October reveal, and that would be taken to interpret urgency on the part of the ECB, and a disregard for the strength in the euro. It’s the latter point that would cause the euro to rally.

Finally, I don’t want to say that something is impossible, but it’s incredibly unlikely that Draghi and the ECB will reveal detailed plans regarding the tapering of QE tomorrow. The wide consensus will only be to announce they want to start tapering QE.

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The Case for Investing in Europe (Updated), April 25, 2017

The Case for Europe, Updated

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European indices and ETFs exploded to new 52-week highs yesterday following the expected French election results. The likely removal of that French political risk overhang reinforces our bullish thesis on Europe, especially given some wobbling in US economic data recently.

On March 21 we presented “The Case for Europe,” which was our bullish thesis on Europe as a tactical investment idea. Since we presented that piece, the three Europe ETFs we recommended have rallied an average of 4.2% vs. the S&P 500 just being flat over the same period. We think that outperformance from Europe can continue for the coming months, so we are presenting an updated “Case for Europe,” and reiterating our bullish stance on three Europe ETFs.

Bullish Factor #1: Compelling Relative Valuation. The reasoning here is simple. The S&P 500 is trading at the top end of historical valuations: 18.25X 2017 EPS, and 17.75X 2018 EPS. There’s not much room for those multiples to go higher, and if we get policy disappointment or the economic data loses momentum, markets could hit a nasty air pocket.

(Specific data and ETFs withheld for subscribers – unlock with free trial:

So, while it’s true Europe should trade at a lower multiple vs. the US given the still-slow growth and political issues, those discounts are pretty compelling. In a world where most equity indices and sectors are fully valued, Europe offers value.

Update: The valuation gap still remains and European indices trade at a still steep discount to the S&P 500. We continue to think we can see multiple expansion in Europe that can help European stocks outperform their US counterparts.

Bullish Factor #2: Ongoing Central Bank Support. This one also is pretty simple… the ECB is still doing QE. The ECB is still planning to buy 60 billion euros worth of bonds through December of this year. That will support the economy, help earnings and push inflation higher, all of which are positive for stocks.

Update: The ECB reacted dovishly to perceptions that it might prematurely end QE or raise rates, and with inflation metrics still uncomfortably low, the chances of a hawkish surprise from the ECB anytime soon are low.

Bullish Factor #3: Overblown political risk. We’ve been talking about this for a while, but the fact is that political risks in Europe are overblown, and just like people underappreciated risks in 2016, I believe they are now overreacting to Brexit and Trump by extrapolating those results too far.

Going forward, there are really two important elections this year: France and Germany.

Update: Macron beat Le Pen in the first round of voting, and according to both the Harris and Ipsos polls taken right after voting on Sunday, Macron holds a large 64% to 36% ad-vantage ahead of the May 7 election.

Turning to Germany, they will have elections in September, and Social Democrat leader Martin Schulz will challenge Merkel for the Prime Minster position. Schultz is a former President of the European Parliament, and he’s not anti EU at all. So, if he wins, from an EU outlook standpoint, it isn’t a negative. Now, I’m not going to get into the details of his politics, because they aren’t yet important for this investment. The bigger point is that it’s not really a problem for the European economy if Schultz wins.

Bottom line, we’ve done well in international investments in the past (Japan during Abenomics, Europe when they started QE), and we believe this is another opportunity to outperform.

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