A number of major events have happened over the last several months in global markets.
We saw oil prices collapse last fall. We also saw the US dollar establishing a strong uptrend against all major currencies. In January of this year, the European Central Bank announced a very large quantitative easing program (QE) to help revive the chronically depressed European economy. We also got another take at the Greek bailout drama. That showdown quickly evaporated as the newly elected Greek government ended up accepting the European Union’s deal pretty much as-is, despite all their harsh talk against austerity. Frankly, their alternative was much worse.
Meanwhile, the Federal Reserve is talking about increasing interest rates later this year, breaking the low-and-going-lower interest rate pattern they’ve established during the financial crisis. This comes on the back of another earlier Federal Reserve decision last year to slowly wean off the markets from its quantitative easing bond buying program. Translation: a very important buyer of financial assets is now going away.
All these events are very meaningful by their own rights and are the kinds of things that can change markets. So it’s a worthwhile exercise to look at the big picture and analyze how this could all come together over the next few months. In other words, are the markets currently undergoing an important inflection point?
Is The US Stock Market Expensive?
Expensive vs. cheap is a concept that only exists in the eye of the beholder. The seller thinks the asset being sold is expensive, while the buyer thinks exactly the opposite. After all, this is why they want to respectively sell and buy the same asset.
Having said that, it’s a good idea to put the current market in some historical context. Consider these observations:
- The S&P 500 has been going up for 6 years in a row now, with the current bull market having started on March 10, 2009.
- It rose by over 200% during this period, making it the third strongest bull market since 1900. The other two were the bull markets ending with the 1929 market crash, and the 1999 dot-com bubble, also ending with a 50%+ bear market. So the precedents are not good from that standpoint.
- We haven’t seen a 10% market correction since September 2012, over 2.5 years ago. It is considered healthy behavior for the market to have a meaningful (over 10%) correction once a year or so. This tends to clear out the speculative excesses and discourages investors from being too greedy and buying too much stocks on margin for example.
- The Federal Reserve has made it clear that the next move in interest rates is up, and it could happen as early as June or September. Rising rates put a headwind on the stock market in general. This is especially true after an extended period of very low rates coupled with strong market gains, like we’ve had during the past several years.
- The Federal Reserve started last year to reduce its QE bond buying efforts and pull back on the money printing press. It should be no surprise that the massive QE efforts of the last several years have been a huge driver for increasing stock prices.
What’s the point of all this? I don’t make predictions, so please don’t ask. However, I do assess relative risks, and it seems to me that there is a lot more risk in the US stock market now compared to only 12 months ago. In my opinion, it’s reasonable to expect more volatile times ahead at the very least, and I would not be surprised to see a major market correction in the coming months.
What About European ETFs and Stocks?
Europe, on the other hand, is a different story. European economies have been plagued by recessionary forces since the financial crisis. Some countries like Spain have been in borderline depression. But in January of this year, the European Central Bank (ECB) has finally embarked in a long overdue QE program, not unlike what the US Fed has been doing for many years now. Combine this effort with a much cheaper Euro and lower oil prices, and you have a compelling situation that should help restart economic growth.
Meanwhile, European ETFs and stocks are beaten up due to sub-par economic performance of the Euro zone in the past few years.
Taken separately, each of these factors would help drive up European stock prices. But combining them together gives us a potent mix that should light up some serious fire under European ETFs and stocks. To summarize, we have:
- Reasonable European stock valuations
- A central bank that is working hard to restart growth via an aggressive QE program
- A much lower Euro (near par to the dollar!)
- Much cheaper oil prices
Of course, none of this is without risks. In particular, Ukraine and Russia are physically close by and unfortunately bring some geopolitical risks to the situation. Overall however, and given the relative high prices of US stocks, it seems to me it’s a good bet to allocate part of a diversified portfolio to Europe. This can easily be done using European ETFs, through either the broadly diversified type or the single country type. For example, iShares provides many decent choices: IEV provides broad European exposure, EWG invests in Germany, EWQ in France, EWP in Spain, and EWI in Italy, just to name a few. I will openly state that I own these ETFs as part of my own diversified European ETFs portfolio.
Please read the disclaimer on this site before considering any investments. And of course, you should never buy any securities without first consulting with your financial adviser. Enjoy!