Submitted by Alexander Gloy of Lighthouse Investment Management
The mystery of the equity investor
#339966;">Performance of international stock market indices in local currencies. Source: StockCharts.com
Looking at the performance of international stock markets over the last 200 days, the German Dax index stands out. But why?
Sure, Germany is an island of prosperity amongst the European
turmoil. Low unemployment, strong economic growth and a stable political
You could argue if it makes sense to distinguish between Deutsche
Telekom and Telefonica on the basis of where they are headquartered. But
aren’t the largest companies (hence those included in stock indices)
serving similar customers in similar regions? Isn’t Volkswagen selling
more cars in China than in Germany anyway? 50% of BMW’s growth
contribution from China?
Or are equity investors following bond investors in a flight from the
PIIGS (Portugal, Italy, Ireland, Greece, Spain)? For bond holders, a
break-up of the Euro zone would be dramatic, as issuers will either
force conversion into (new) local currencies (leading to currency
losses) or find themselves unable to service Euro debt and default
(leading to haircuts on principle).
But equities? Imagine what a break-up of the Euro would do to German
exports to those countries. Stock markets in weak currency regimes are
usually, at least in local terms, appreciating. But for German stocks
this would be a negative.
If weak countries leave the currency zone, the Euro could actually
re-strengthen (or, if Germany decides to quit, a strong New Deutschmark
would have the same effect on German exports).
Looking at the under-performance of Spanish and Italian stocks leads
to another explanation: international investors are withdrawing from
countries in danger of being future candidates for bail-outs (with the
usual prescription of spending cuts and tax hikes that could damage
local net profits and/or lead to political instability).
However, once Spain tumbles, the costs of bail-outs will become
astronomical and overwhelm the cohesion of the Euro-zone. Things will
get out of control quickly if only for the unavoidable bank runs
(depositors in weak countries withdrawing their Euro deposits before a
mandatory exchange into a new currency). Government “guarantees” of
deposits will become worthless once the government is bankrupt, too (as
seen in Ireland).
Equity investors have an admirable lightheartedness amidst an outlook
which can only be described as dire. Do they understand they are the
last asset class to get paid back? When a company cannot pay back its
debt, the equity is usually worthless. The same applies on a national
level. Before a country goes bankrupt, it will apprehend all available
profits (if any) and funds at companies in its jurisdiction. Surely some
profits can be stashed away at foreign subsidies, but which investors
will rely on those when pictures of rioting masses are dominating the