How much is discounted?
Having said that, there is no question that valuation levels are attractive for a reason. Europe’s outlook is murky to say the least. It could very well be that earnings estimates for 2012 are wildly optimistic and that earnings will actually fall from this year to next. It is also possible that we could be entering an extended period of subdued economic growth. However, we must remind ourselves that it is not a question of what happens next but to what extent such calamity has already been priced in.
Bloomberg publishes a quarterly survey of global investors. The most recent one was published on the 26th September. The results reveal an astonishing amount of gloom directed at Europe:
- 88% say the eurozone economy is deteriorating while 75% expect it to fall into recession within the next 12 months.
- 40% predict the eurozone will lose at least one member in the next year and 72% expect at least one country to abandon the eurozone within 2-5 years.
- 51% say the euro zone will collapse eventually but only 8% expect it to happen within a year.
- 93% say Greece will eventually default while 56% expect Portugal to face the same fate.
- 67% believe US officials have handled their economic challenges the best; only 11% believe European officials have done the best job.
- Less than 20% expect the EU’s markets to offer the best investment opportunities over the next 12 months whereas 53% suggest that they actually offer the worst opportunities in the world.
Source: Bloomberg.
Frank Veneroso kindly pointed me towards this study, stating that “this is simply enormous pessimism.” The Bloomberg survey confirms to me what I already suspected. I believe a Greek default is now fully discounted. So is a eurozone recession within the next year. The one risk factor which is probably not fully discounted yet is the systemic risk associated with Greece defaulting on its debt. If the authorities cannot contain the domino effect, European equities could fall further.
The extreme level of pessimism is further documented in Citibank’s euphoria/panic model which shows that investors are currently extremely bearish (see chart 6). While Citi’s model is US centric, it goes to show that even if the drawdown in US equities has been less dramatic than losses on this side of the Atlantic, pessimism is widespread.
