Don't panic – buy stocks instead

By MoneyWeek editor-in-chief Merryn Somerset Webb Jun 06, 2012

The last month has been good to the bears - most of our scariest predictions are finally coming good.
India and China are slowing faster than most expected; the US recovery is fading; the eurozone is imploding; and even the greatest of optimists accept that a global recession is likely – which would make this the first time since the 1930s that the likes of the US and the UK have entered a new recession before regaining the ground lost in the last one. Not good.

On the plus side, it is so bad that investors are finally losing hope that all will end well. Suddenly, the people who have spent the last decade buying stocks on the dips and telling me to stop being such a misery guts are circulating notes forecasting (variously): the nationalisation of the entire European banking system; the shutdown of global stock markets; protectionism; capital controls; the confiscation of personal holdings of gold; and “the end of fiat money”.
They’re also selling those stocks they bought on past dips. That’s why the MSCI Euro index ended May down 8.6% and poor Spain has just seen its Ibex index fall 13% in a month to a nine-year low. How’s that for misery?
So what should you do while everyone panics? You might want to take a very deep breath and buy some European stocks.
I mentioned a few weeks ago that, on the cyclically-adjusted price/earnings (Cape) ratio, several markets were beginning to look very cheap indeed. They are now cheaper.
Russell Napier of CLSA (who provided me with the Cape numbers) tells me that Portugal, Ireland, Italy, Greece and Spain are “all well into buying territory” if you look at them on a ten-year view (this is, to be clear, not the case in the UK or the US).
Greece is on a Cape of 1.8 times (the long-term average for most markets is around 15 times). Buy at a Cape of under 10 times, and history suggests you’ll see a compound annual growth of more than 14% in the next decade.
History guarantees nothing, of course. You could say that the likes of Greece and Spain have had the wrong interest rates for the past decade (the rates that suited Germany) so their past valuations are irrelevant. You could say that nothing can be cheap enough given what’s likely to happen next. You could, as Napier does, remind me that it is possible for bad policy to turn a whole stock market into a “doomsday machine”.
Back in the 1970s, high taxes and high inflation meant the UK stock market came to be seen just that: any profits made were purely inflation-linked but were taxed anyway (a bit like capital gains tax today). So investors stayed away.

You could create a similar doomsday machine in Europe today by continuing to force “vastly over-indebted countries to deflate their way back to competitiveness within the single currency,” says Napier – bringing on a cycle of falling corporate revenues and bankruptcies.
But, given the nightmare that would result from this, he reckons a change in monetary policy is more likely. The market no longer seems to believe that the end game is unlimited money printing in Europe (either via the central bank or the national banks) but it is still the most likely one – and the one that will make equity markets turn.
And as for a government bond default – the thing the market really worries about – it doesn’t have to be the end of the world. Bedlam Asset Management – no stranger to a bearish view – has written a relatively unhysterical note that reminds us that the 1997 Asian crisis was nasty, but not terminal.
Most Asian countries bordering the Pacific “underwent some form of default.” They then reacted in some of the ways investors think Europe soon will: Malaysia went for capital controls, Singapore for huge market interventions and Korea for a “virtual shutdown of international banking”.
In every case, thanks to default and reform, GDP was higher three years later than it had been before the crash.
Markets are expectations machines. Right now, Europe’s markets are discounting all the problems but none of the solutions.
It is also worth noting that, when crisis-hit markets turn, they really turn. The FTSE All Share hit its low on January 6 1975. It then rose 44% in eight business days. Bull markets come out of nowhere. That should make you worry about missing the bottom. The best returns will probably come from the worst of markets – Société Générale suggests Italy.
Finding a fund that recognises this is not easy. Managers in Europe are weirdly obsessed with Sweden, Germany, Switzerland, the luxury goods sector and Nestlé.
According to Hargreaves Lansdown, the SVM Continental Europe Fund is the most exposed to Greece, Spain and Italy, Portugal and Ireland: 28.5% of the portfolio. But you might also look at the Cazenove European Fund. Its manager Chris Rice has about 10% of the fund in Italy and 5% in Spain and he tells me he is selling out of Nestlé. That at least sets him apart from the crowd.
• This article was first published in the Finacnial Times
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