The Economist Asia Edition - June 09, 2018

The EconomistJune 9th 2018 Finance and economics 63

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I

N AN episode of “Seinfeld”, a 1990s tele-

vision comedy, George Costanza, a seri-

al failure played by Jason Alexander, de-

cides that every instinct he has is wrong.

So he resolves to do the opposite. He is

soon squiring a new girlfriend and is up

for a dream job. “It’s all happening be-

cause I’m completely ignoring every urge

towards common sense and good judg-

ment I’ve ever had,” he says.

Success in investing often means going

against the grain—and your own feelings.

To do otherwise is to be swept along by

the general greed and fear. Still, fear is a

useful emotion. It would be unwise, for

instance, to ignore the recent turmoil in It-

aly, where bond yields spiked in response

to concerns that the country might be on

the road to leaving the euro. Though the

worst fears have subsided, the coalition

that was eventually given the president’s

blessing to form a government looks ca-

pable of causing trouble.

A natural inclination in the circum-

stances is to turn away from euro-zone as-

sets—not just bonds (where the rewards

are notably scanty in relation to the risks)

but equities, too. Yet such instincts can be-

tray investors. There is an argument for

buying euro-zone shares precisely be-

cause their defects have now become all

too clear to everyone.

Among the shortcomings is that Eu-

rope is ageing. It is the place to find busi-

nesses ripe for disruption, rather than

those doing the disrupting. Its bourses are

heavy with the technologies of the second

industrial revolution—mass-market cars,

petrochemicals and machinery—but light

on the digital firms that power stockmark-

ets in America (see chart). Its banks, a big

weight in stockmarket indices, look leaden.

Deutsche Bank is a target of short-sellers.

Last year’s strongGDPgrowth has cooled.

To cap it all, there are glaring holes in the

euro area’s design. There is no continent-

wide deposit or unemployment insurance,

for instance. A nasty recession could plau-

sibly breakthe zone apart.

So there is plenty not to like. The experi-

ence of owning European stocks over the

long haul has been quite horrible. The Euro

Stoxx 50 of big euro-zone shares is no high-

er now than it was 20 years ago. Its broader

sibling, which contains 300-odd compa-

nies, is well below its peak in the summer

of 2000. The inclination to steer clear is

quite natural. But there is a strong case for

doing exactly the opposite.

For a start, euro-zone equities look

cheap. The earnings yield on the Euro

Stoxx 50 is 6.4%. That compares with a 4.8%

earnings yield on America’sS&P500 index

and is handsome for an economy where

holding cash pays less than nothing and

where the safest government bonds pay a

negative yield after adjusting for inflation.

Patience may be required. But over time

the chances that a punt on euro-zone equi-

ties pays off are good.

What is more, there is room for earnings

to improve. Take banks, for instance. Bad

loans and the need for more capital had

been a continuing drain on their profits.

But now even Italy’s big banks are in de-

cent shape. “If at any point interest rates

turn positive, you could see huge earn-

ings upside,” says Eric Lonergan, ofM&G,

a fund-management group. Similarly, oth-

er firms, which still had to fork out on

wages and rents during the euro zone’s

depressed years, could squeeze out more

profits if the economy keeps growing. In

America, by contrast, there is no compara-

ble scope for earnings to accelerate, be-

cause the economic cycle is more mature.

To be sure, the euro is a rickety con-

struct. Countries are also currency zones

and they work tolerably well because of

fiscal transfers from rich to poor regions.

That is absent in the euro area—hence the

fear of break-up. Even so, it is far from ob-

vious that this should be ranked higher

than any number of other uncertainties.

What investors choose to worry about

changes. At the beginning of 2016, for in-

stance, China’s debt mountain was a

source of terror for financial markets.

Now it elicits a yawn. Few have yet

mapped out the implications for markets

of President Donald Trump’s foreign poli-

cy in the way they have done for a

break-up of the euro. Yet it might turn out

to be of greater consequence. The risks to

the euro are simply more salient. And

when risks are more palpable, people

tend to give them too much credence.

Instinct does not always serve inves-

tors well. The political tremors in Italy are

more like a scare than a rerun of the crisis

of 2012. In which case there is money to be

made from European equities, says Mr

Lonergan. So remember George Cos-

tanza. When every urge tells you to shy

away, consider doing the opposite.

The wisdom of George

Mechanical Europe, digital America

Source: Bloomberg *At June 6th 2018

Stockmarket by sector*, %

Euro

Stoxx

S&P

500

Financials Industrials discretionaryConsumer

Technology

Consumer

staplesMaterials

Health care

Energy

Utilities

Telecoms

Property

Other

Buttonwood

Or the case for owning euro-zone shares

Economist.com/blogs/ buttonwood

would be much less likely and there would

be no need for taxpayer-funded bail-outs.

Similar ideas floated among economists in

America in the 1930s, but have never been

put into practice.

The initiative’s opponents, which in-

clude the Swiss government, the SNBand

the banks, say sovereign money would in-

cur large costs for little gain. The transition

to Voll gel dwould be expensive and unpre-

dictable as banks reorganised themselves

and sought alternative, dearer, sources of

funding. Interest rates would rise, at great

cost to the Swiss economy.

Daniel Kalt, an economist atUBS, a

bank, believes that sovereign money

would not stop financial crises. In 2007-08

a seizure in interbank funding, rather than

bank runs, toppled financial institutions

with no retail deposits, such as Lehman

Brothers. Thomas Jordan, the head of the

SNB, has argued that sovereign money

would not prevent banks from granting

risky loans or overestimating future re-

turns. Today’s macroprudential rules will

do more to avert a crisis than tearing down

the system.

Sovereign money could also compli-

cate monetary policy. Rather than setting

interest rates to influence bank lending, the

SNBwould have to control inflation by reg-

ulating the amount of cash in circulation

directly. The SNBalso frets that, if granted

the power to distribute money and credit,

it will become embroiled in politics.

With opinion polls suggesting that only

a third of respondents will vote in its fa-

vour, the radical initiative is unlikely to

pass. But authorities in several countries

are contemplating the merits of digital cur-

rencies, which could allow the public to

hold deposits with the central bank. Voll -

geldmight not pass, butsome more cau-

tious monetary experiments may well be

on their way. 7