- As the economy is doing well and interest rates are low it is easy to put out fires.
- Greece, Italy, Spain, Portugal, Croatia are just a few countries that will feel the heat of higher interest rates.
- We use the currently blocked biggest Croatian company, Agrokor, as an example of what can happen.
The Euro might be considered one of the global ‘go to’ currencies but do not forget that the European currency is not even 18 years old, thus still a teenager. Apart from a young currency the main risk Europe carries comes from its segmentation.
The UK recently triggered article 50 in order to leave the European Union. The markets didn’t react to that news as there is plenty of liquidity and nothing imminent is going to happen. However, the UK triggering article 50 and other factors that we are going to discuss show how vulnerable Europe is. European vulnerability is perhaps the reason why Warren Buffett has avoided investing Europe all along while the few investments he made weren’t that successful, think of Tesco.
The problem with Europe is that there is an immense number of places that can create problems. As long as everything is fine nobody is concerned, but things always eventually turn for the worse. When that happens, there will be a sell-off in the markets and stocks will become cheap. Only when stocks are extremely cheap it is the right moment to invest in Europe, all other moments are simply too risky.
Figure 1 The Stoxx Eurpe 600 index didn’t go anywhere in the last 17 years
The last sell-off was in January of 2016 when European stocks dropped 25%, before that we had the Greek crisis in 2011 and 2012, the Great Recession of 2009, the dot-com bubble. On average, every 4 years there is something that happens and sends European stocks down. What will trigger the next sell-off I do not know, I know there will be one and it will be a bad one as valuations are extremely high.
In order to avoid discussing the usual suspects like Greece, Italy, Portugal, Spain or the UK and the Brexit I will discuss another country that probably won’t create problems but shows how risks in Europe are everywhere. I will shortly discuss Croatia and the recent systemic risk coming from the near bankruptcy of its biggest corporation, Agrokor. Agrokor accounts for a significant part of the Croatian economy with its 40,000 employees and due to a lending spree that has been going on since the country’s independence the company is in jeopardy. Agrokor’s bond quickly lost 50% of its value.
Figure 2 Agrokor’s 9.875% bond traded on the Berlin stock exchange
Source: Berlin Boerse
Companies go bankrupt all the time but this is a company that is extremely important for the Croatian economy. Its bankruptcy can quickly cause chain reaction that could lead to a liquidity crisis and increase the borrowing term under which the severely indebted country can borrow.
Figure 3 Croatia has excellent borrowing terms but if that changes and a recession comes along the country’s financial system will be in jeopardy
Source: Trading Economics
On the other hand, the Agrokor crisis will probably be solved as it is a company too big to fail and the government got involved. However, it is easy to put out fires when there is plenty of liquidity and the economy is growing. My concern, and something that every long-term investor should be concerned about is whether the system, as is, is sustainable.
Europe will survive but there will be many scary moments coming from country specific systemic risks or important companies going bankrupt. As investors we care how such fires affect the markets. Since the Agrokor crisis happened stock prices on the Croatian stock exchange have been declining, especially companies from the Agrokor holding.
Figure 4 A typical day on the Croatian stock exchange since the crisis
You are probably not interested in investing into Croatia but as other countries have also companies that if in trouble would create systemic risks it is a good example of what can happen in Europe and why investing in Europe is risky at this point. As examples of companies that can lead to systemic risks just think of the Italian banks or Deutsche Bank.
Conclusion and portfolio positioning
General investments in Europe are far riskier than investments in the U.S. At the same valuation the risk reward outlook is negative. Investors should therefore monitor what is going on in Europe and wait for lower prices. Apart from waiting there are always individual opportunities that can give nice short term returns like La Doria, an Italian tomato company that we discussed a few months ago. Since then the company is up 30%.
Why am I saying that the best investments are to be made in the middle of a European crisis? Because a crisis is like gravity and pulls the price of all stocks down as we have seen in the above Croatian stock exchange examples. Among those stocks there are ones whose businesses are completely unrelated to what is going on in Croatia and its systemic risks. Further, after a crisis happens humans always find a way out. Therefore, a crisis just brings to temporary low prices, or great buying opportunities. Subscribe to Eurostockpicks as we are going to analyse European companies in order to create a watch list so that we can be ready to buy when the next crisis or recession comes.