Goldman's European Clients Are Oblivious About Developments In Europe
In David Kostin's latest weekly chart book, in addition to the plethora of useful charts (if materially incorrect when it comes to fund flow data - never before have we seen such as disconnect between Lipper/AMG and ICI flow data, allowing one to pick and chose which data set to use depending on their point), and market statistics, the Goldman head strategist observes a rather curious psychological schism, notably as pertains to investor sentiment regarding the financial powderkeg known as Europe. Namely that while US investors just need to read a Euro-negative headline to sell everything, in Europe Goldman's clients are largely oblivious of any and all adverse developments. To wit: "Our meetings with clients in Europe and the US during the past two weeks showed investors in continental Europe to be more composed about the direction and pace of policy decisions. US and UK investors are far more anxious about potential policy solutions and the cumulative impact of a drawn out resolution." We wish we could recreate the European nonchalance, in no small part predicated by the general mindset of a socialist backstop to another global collapse, which in case of failure, will simply mean the activation of US-based FX swap lines, and thus America would have to bail out Europe once again like it did back in 2008. In retrospect we can see why nobody in Europe is too worried. Also, perhaps Goldman should do a better job at distributing the report by its own Alan Brazil saying Europe is doomed...
We wonder how many of these very unconcerned investors will step up and fill Buffett's shoes who as we disclosed yesterday has been approached to bail out one or more unnamed European banks. Kostin's conclusion: "Investors continue to vote with their feet in US equities..." Feet...Or wallets. Then again not everyone has the benefit of trading with other people's money, and in a worst case scenario, that of the Fed.
Investor sentiment and intraday market action remain focused on news flow and speculation regarding policy developments in Europe. Our meetings with clients in the US, UK, and continental Europe during the past two weeks revealed a clear delineation between the views of those located in Europe and those looking towards Europe. Investors continue to vote with their feet as evidenced by mutual fund outflows and smaller net equity futures positions since the end of July.
Investors “on the continent” are more composed about the direction and pace of policy decisions. Perhaps reflecting a home field advantage in understanding the region’s culture and politics, local investors are less anxious that periphery countries ultimately will receive support and less concerned about the day-to-day public conjecture. One worrying takeaway is that European politicians seem less sensitive to swings in asset prices and thus may be more tolerant of declines than in other regions of the world.
Investors outside Europe are far more worried about potential policy solutions and the cumulative impact of a drawn-out resolution. Clients in the UK and US were more negative than those in Europe particularly around the methodical nature of the debate. There is genuine concern among this group that growth, financial conditions and the total cost of resolution are negatively impacted each passing day. Outsiders are also acutely concerned about the impact of fiscal tightening in Italy, Spain and Greece will have on economic growth and place a higher probability on a break-up of the euro than “locals.”
Investors in both camps continue to wrestle with the types of stocks to own given high uncertainty and risks to growth. Goldman Sachs Investment Profile (IP) scores show investors shifting stock selection to high return stocks (ROE, ROCE, CROCI) from high growth stocks (EPS, Sales, EBITDA) during QE2 (Exhibit 1). Other pockets of outperformance include strong balance sheet companies (Bloomberg ticker <GSTHSBAL>) and those without reliance on government spending. Stock selection has been further complicated by elevated correlation as we highlighted last week.
Stock correlation is higher in the US than Europe. Over the past three months the average correlation of S&P 500 stocks is at an all-time high of 0.73 versus 0.59 for DJStoxx 600 stocks, which is below the level from July 2010 (Exhibit 4). A similar gap existed in late 2008 during the US financial crisis and recession but it is somewhat surprising that European stocks have lower correlation given that they represent the current source of uncertainty. Potential reasons include short sale bans in Greece, Spain, France and Italy along with higher US liquidity and country-specific factors.