From the outside looking in, Europe looks like a large, polygamous family in the early stages of a messy divorce. Last week, a French government paper was leaked accusing German Chancellor Angela Merkel of “selfish intransigence” and of thinking only of the “trade balance recorded by Berlin and her electoral future.”
In an implied attack on Merkel and the German position, Italy’s new prime minister, Enrico Letta, has sounded off saying that “Europe’s policy of austerity is no longer sufficient” and has put stimulus back on the agenda.
Angela Merkel hasn’t exactly been quiet herself. Apart from the usual string of calls for the rest of Europe to cut spending and raise taxes, she has waded into taboo territory by publicly offering policy advice to the European Central Bank.
Merkel suggested that rates needed to rise in Germany, even while they remained low in the crisis countries such as Italy and Spain. She suggested too that the ECB needed to do more to make sure that funding gets where it is needed most: to Italian and Spanish small and medium sized companies.
And about that…
Mario Draghi got the attention of the capital markets in his last press release. Draghi said that, in an attempt to force eurozone banks to push funds into the real economy, the ECB would consider negative deposit rates on the funds its holds for banks— or what effectively amounts to a tax on banks on the funds they are not lending.
Stop for a second and read that again. The ECB is contemplating shaking banks out of their complacency by taxing deposits that they are not lending.That is a mild short-term negative for our two Eurozone banks, Banco Santander (NYSE:SAN)and Banco Bilbao Vizcaya Argentaria (NYSE:BBVA).
But it is a potential watershed moment in the eurozone crisis because it shows a willingness to act by the ECB that we’ve never seen before.
Meanwhile, the bond market continues to show its support. Take a look at this chart (Figure 2):
The Spanish 10-year government yield continues to drift lower and is now barely above 4%. Italy’s 10- year yield has actually drifted below 4%, and this despite a three-month political crisis in which the country lacked a functioning government.
And remember Slovenia? The tiny Alpine country that was supposed to be the next domino to fall?
Well, Slovenia just successfully issued $3.5 billion in new bonds with yields between 4.95% and 6.00%, well below what most of the doomsayers predicted. For now, it looks like Slovenia will avoid needing a bailout.
Think the euro is dead? Don’t tell that to Latvia. Barring any snafus in the second half of this year, Latvia will become the newest member of the eurozone in January. And Poland, a much larger and more significant economy, reiterated last month that it wanted to adopt the euro as its currency “as soon as possible.”
And as I alluded at the first part of this section, it looks like the German austerity regime of austerity is reaching the end of the line. It should.
You might be a little surprised to hear me calling for the end of austerity. After all, as a free-market advocate, shouldn’t I be in favor of anything that seeks to shrink the size of the government?
I’ll answer that question with a question of my own. What makes more sense, to take a chainsaw and indiscriminately cut away at the government from all angles or to focus instead on the areas where the government really gets in the way of the private sector’s ability to create wealth, such as in out dated labor laws and productivity -sapping regulations?
I think you know the answer. And the good news is, so do an increasing number of Europe’s leaders.
As you can see by America’s own political paralysis, it’s tough to push through meaningful reforms when times are good (or when they are not too terribly bad). Most everyone agrees that America’s farm subsidies are absurd, its income tax system is a complicated mess and that its Social Security and Medicare system are insolvent over the long-term.
But none of these will get fixed unless there is a proverbial gun to Congress’ head in the form of a financial crisis.
This is where Europe is today. They’ve finally reached that point. Spain had one of the worst labor markets in the world, and it was almost impossible to fire anyone no matter how incompetent they were.
Italy and Greece were not far behind. And now, because these countries are desperate for growth, the reforms that should have been implemented decades ago are finally being implemented.
There is even a push for a free-trade agreement with the United States…protectionist Fortress Europe. President Obama—a man whose own trade record is muddy at best—recently announced his intentions to pursue a “Transatlantic Trade and Investment Partnership.”
The President desperately wants a legacy, and Europe is desperate for growth. It’s a marriage of mutual desperation, but we’ll take it.
What is the takeaway from all this?
Simple. Europe is quietly fixing itself, which means we should see massive gains in European stocks as investors reassess the risks facing the eurozone. Europe is not “fixed” yet and it won’t be for a long time. But if we wait until all of the kinks are ironed out, it will be too late to invest. The time is now, when prices are cheap and sentiment is muddled at best.
All of our European positions remain a “buy.”
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.
