European stocks are among the cheapest in the world. As a value investor, I like to think that an attractive price is its own catalyst for a stock, though taking this approach generally involves patience.
But why wait if you don’t have to? Right now, we are on the cusp of one of the greatest rallies of our lifetimes. Not only are European stocks cheap, but they’re about to get the mother of all catalysts from the European Central Bank.
Here’s what you need to know … and how to profit from this enormous tailwind.
European stocks are following the same trajectory as U.S. stocks on about a two- to three-year lag. The U.S. emerged from its financial crisis in early 2009 and implemented “QE Infinity” in late 2012. Europe emerged from its sovereign debt crisis in 2012 and — it appears — will be putting its own quantitative easing program into place later this year.
Let’s take a quick look at what ECB President Mario Draghi is doing. There are four basic parts to the plan he announced earlier this summer:
- The European equivalent of the fed funds rate will be lowered from 0.25% to 0.15%.
- A negative interest rate of -0.1% will be imposed on deposits held by member banks at the European Central Bank.
- The Long-Term Refinancing Operation (LTRO), an emergency bank funding program put into place during the pits of Europe’s crisis, is being resurrected as a “targeted LTRO” designed to get liquidity to the non-real-estate private sector.
- Draghi announced that plans are being made for a quantitative easing program: “The Governing Council has decided to intensify preparatory work related to outright purchases in the ABS market to enhance the functioning of the monetary policy transmission mechanism.”
Let’s start with the first two ECB action items. Draghi’s lowering of interest rates — and particularly his lowering the deposit rate to negative territory — have stolen most of the headlines. But in my view, these are the least important by a wide margin. The big story is the targeted LTRO.
This program will deliver some much needed capital to Europe’s small and medium-sized businesses. Europe’s large multinationals have access to the international bond markets, and funding has not been much of a problem for them throughout the years of on-again, off-again crisis. But smaller companies that depend on bank loans have been starved of credit for years as the banks hoarded capital to repair their balance sheets.
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Draghi’s plan is to make up to €400 billion available via targeted LTRO starting in September. We’re talking about €400 billion being injected into real-economy businesses, not government or mortgage bonds. Banks would be able to borrow from the ECB for four years at an annual rate of just 0.25%. The only problem I see here is one of image. Banks would be foolish not to take advantage of targeted LTRO; it’s virtually free money that can be used to make profitable loans.
Now the news we’ve all been waiting for: eurozone quantitative easing. In the U.S. variety, the Fed made massive purchases of Treasury bonds and mortgage-backed securities. Mr. Draghi had something a little different in mind: large-scale purchases of asset-backed securities backed by loans to small and medium sized businesses.
In plain English, this means that the ECB is planning to buy pools of loans made to small and medium-sized businesses in the eurozone. The idea is that banks will be more willing to make loans to Main Street if they have a ready buyer for the loans in the ECB.
Why asset-backed securities and not government or mortgage bonds? Yields in the eurozone are already scraping near record lows. Pouring more cash into these bond markets would accomplish very little at this point.
The ECB has been quiet as to the size of its coming quantitative easing program, but it’s not unreasonable to think that, between targeted LTRO and the new QE, the ECB will be throwing upwards of a trillion euros into the lending market for small and medium-sized businesses.
That is a big bazooka.
So what does all this mean for investors?
I expect European stocks — which, as I said, are significantly cheaper than American stocks — to enjoy a monster rally over the next one to three years. But within the universe of European stocks, I consider the banking sector to be the most attractive and the most directly leveraged to the ECB’s plans.
European banks have spent most of the past five years trimming their balance sheets; growth has not been a priority. But now, with their operations already streamlined and their capital ratios at generational highs, it’s time to start making loans again.
One bank I particularly like is Spain’s Banco Santander (SAN). Spain’s economy is turning the corner, which should do wonders for investor perception of the bank. But the bullish arguments go well beyond Spain. The beauty about an international bank like Santander is that it takes advantage of ridiculously low borrowing rates in Europe and lends more profitably in Latin America. Santander is also cheap, trading at just 1.2 times book value, and sports an attractive dividend of over 6%.
Don’t miss this enormous story unfolding in Europe. Big European banks are about to undergo big, government-backed growth — and it’s not too late to get on board.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.