All Over the Map on Europe

Run for your life-too much euphoria! Pile in-quantitative easing will make stocks soar! Own the US instead-P/Es are lower there. Forget the US and go hogwild for the eurozone-its cyclically adjusted P/E (CAPE) is way lower! This is just some of the conflicting advice we've seen about eurozone stocks, which were among the world's strongest in February. And it could all lead investors to a weird place, ignoring or going all in on eurozone stocks for bizarre reasons. Investing isn't about choosing between country A and country B or going all-in or all-out one region. It's about global diversification. With reality better than most perceive, we think there are great reasons to own eurozone stocks-but as part of a global portfolio.

The trouble with the headlines' recent advice? It assumes global investing requires choosing between countries-these days, that false choice is between the eurozone and US. Headlines argue over which has the best "contrarian" play. They miss the elephant in the room: What if they both do great? Yes, the US and Europe can and have outperformed the world simultaneously. Since 1988, it has happened in eight calendar years.[i] Investing isn't about owning the US or Europe. US or foreign. Europe or Asia. Canada or Australia. Developed or Emerging Markets. If you view it that way, you'll likely end up chasing your tail, flipping around often-rarely a winning endeavor.

Instead, think globally! The world is a big place, and countries and regions come in and out of favor often. If you exclude either Europe or the US based on a presumed false choice, you ignore huge chunks of global market cap, opportunities and risk management. We think folks are best off starting with the biggest opportunity set: View the entire world as a place with potential plusses and minuses. Put more money where you think the plusses are, but always remember you could be wrong, so put some money where you think the minuses are-just in case. Take Japan-a minus, in our view, but we wouldn't encourage anyone to ignore the world's third-largest economy entirely, because what if? Exclusion creates blind spots, and blind spots can be deadly.

So then, what to do about the eurozone? Own it! But not for the popular reasons. Take QE. In our view, the media sees QE wrong. It isn't a rising tide that lifts all boats-it's a downer. Money from asset purchases doesn't flood into stocks. In the US and UK, it just sat on banks' balance sheets. Perhaps it won't sit on European bank balance sheets, since the ECB charges a fee for excess reserves. But it probably won't be lent, either-not with yield curves flat and long-term bond buying adding further downward pressure. Banks seem more keen on arbitrage-finding cheap debt to sell to the ECB for a premium-than lending more. That makes it hard for the new liquidity to hit stocks or the broader economy. That said, the eurozone has already proven capable of growing with yield curves flatter, so QE isn't a deal breaker.

As for valuations, those won't tell you much. Normal P/Es can reveal sentiment, but comparing US and eurozone P/Es is the wrong way to do it-again, false choice! Instead, view each in the context of its own long-term trend-both the US and eurozone show sentiment has improved off rock-bottom levels but remains well below euphoric dot-com heights. CAPE, however, tells you nothing. Not even sentiment. It just shows how prices compare to the last 10 years of (bizarrely) inflation-adjusted earnings, making it an oddly calculated, backward-looking thing. There is way too much skew for it to be useful.

So why go eurozone? Simple: Markets grow on the difference between reality and expectations, and in the eurozone, that gap is huge. Between Greece and rampant (false) fears of a deflationary doom spiral, folks have pretty low expectations for the 19-country bloc. Yet the eurozone is growing. The euro survives everything Greece throws at it, and all sides want it to stay that way. Falling prices aren't killing consumption-retail sales rose again in January! And outside of energy, prices are actually rising. Growth needn't be gangbusters to beat too-dour expectations. Slow and steady can win the race.

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[i] This is based on the S&P 500 total returns, MSCI World and MSCI EMU net returns. 1988 is the first year of MSCI EMU data, and the first decade is built from a backtest-the euro didn't launch until 1998.