Is Europe the next market to boom?...

Is Europe the next market to boom?... German sentiment is improving... Draghi is ready to buy government bonds... Why you should own more foreign stocks... Revisiting CAPE ratios... Germany shuts down coal plants... Why we're bullish on natural gas...
 

Editor's note: The Stansberry Research offices will be closed Thursday for Thanksgiving. We will not be publishing the Digest on Thursday. We hope you enjoy the holiday.
 

 

 European stocks got a boost this morning after the Ifo business confidence indicator – which measures economic development – showed sentiment in Germany is improving. The index rose from 103.2 in October to 104.7 in November, breaking a six-month streak of consecutive declines.

 

That's in addition to last week's positive showing for Germany's ZEW Economic Sentiment Indicator, a survey measuring economic sentiment toward Germany.

 

 As you can see from the chart below, the SPDR Euro Stoxx 50 Fund – a fund holding an index of European blue chips – has rallied from its October lows...

 

 

 And we could see a much bigger rally in European stocks. Investment-research firm BCA Research shows that bounces off the bottom of the Citigroup Economic Surprise Index – which measures the difference between reported economic data and consensus estimates – have signaled big rallies in European stocks since 2010...

 

 

 More important than an economic surprise indicator is that the man with his hand on the printing press – European Central Bank (ECB) President Mario Draghi – reiterated his intention to goose the struggling European economy on Friday...

 

We will do what we must to raise inflation and inflation expectations as fast as possible. [If] our policy is not effective enough to achieve this, or further risks to the inflation outlook materialize, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace, and composition of our purchases.

 

The ECB is already buying asset-backed securities. Now it looks like Draghi is ready for all-out quantitative easing – buying government bonds.

 

 And today, European Union (EU) officials said newly appointed European Commission President Jean-Claude Juncker would unveil a €315 billion plan to attract private investment into the European economy.

 

 But low inflation and a sagging economy aren't Europe's only problems. Stansberry International editor Brett Aitken sent a note this morning explaining another major issue for the EU.

 

But before we get to that, we're going to explain why you're likely far underinvested in foreign stocks... and why that's a mistake.

 

 Most investors have the vast majority of their wealth in their own country. If you live in the U.S., most of your assets (including your portfolio, house, job, etc.) are in the U.S. It's called the "home-country bias."

 

U.S. investors have around 70% of their wealth in their home market, about on par with people in other countries throughout the world.

 

However, as a percentage of the world's market cap, the U.S. is around 50%. Based on that, U.S. investors should have at least 50% of their wealth invested outside of the U.S. But we know hardly anyone actually does this.

 

 Our friend Meb Faber, Chief Investment Officer at Cambria Investment Management, launched an exchange-traded fund to address this exact issue. It's called the Cambria Global Value Fund (GVAL).

 

GVAL looks at 45 countries around the world and ranks them based on how cheap they are. As Meb explained in the April 17 Digest...

 

We take the top 25% of countries in terms of affordability and equally weight those. It ends up being around 11 countries in developed and emerging markets. And if you look across that basket, you're investing in a lot of countries that are consistently the worst of all the geopolitical headlines, like Russia today.   But the geopolitical risk is one of the reasons why these countries are so cheap. We have equal weightings of Greece, Russia, Italy, Spain, Brazil, Hungary, Austria, and other emerging European countries. But that basket of equities is incredibly cheap compared with the rest of the world.

 

 Meb's preferred ratio for valuing these countries is the Shiller CAPE Ratio. CAPE stands for the "cyclically adjusted price-to-earnings." This is the average earnings over the last 10 years, adjusted for inflation.

 

What Meb found is that the more you pay for a market, the worse your future returns are... and vice versa. Today, the U.S. is expensive. From the April 17 Digest...

 

The average country value over time is a CAPE of 17. Markets typically top in the 30s and bottom around seven. The highest value we've ever seen in the U.S. was a value of 46 in December 1999... And the lowest value was around five. And the variance in the ratio is based on what investors are willing to pay for stocks at a certain point in time. So there's a wide spectrum of what people are willing to pay.   Today, the U.S. stands at a rich valuation of around 25. It's not a bubble. People tend to think stocks are either a screaming buy or in a bubble and about to crash. But the reality is, stocks spend most of the time somewhere in the middle.   Anything can happen in the short run... Just look at last year when stocks were up more than 30%. Mr. Market can go up a good bit more. As an investor, you have to be able to contemplate and comprehend the possibility of U.S. stocks hitting a CAPE ratio of 45. That means stocks would double from here... But that would also be an 80% decline if U.S. stocks hit their low CAPE ratio of five.

 

 As Meb noted, we don't know what will happen in the short term. But it makes sense to diversify some of your portfolio outside of U.S. stocks today and into cheaper foreign markets.

 

(True Wealth editor Steve Sjuggerud has been diversifying out of U.S. stocks recently... Today, for example, he's super-bullish on Chinese stocks. It's one of the cheapest markets in the world today... And Steve thinks it could double from here. You can read more about it in today's DailyWealth.)

 

If you want to learn more about the idea of home-country bias and the importance of diversification, Meb generously offered Stansberry Research subscribers a free copy of his book – Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market. Click here to claim your free copy.

 

 Now, back to the issues facing the EU... Stansberry International editor Brett Aitken sent us the following note this morning...

 

Germany just put another eight coal-fired power plants on the chopping block. Reuters reported over the weekend that Germany already has around 50 facilities registered for decommission. But the pressures on Germany to reduce carbon emissions could mean it shuts down an additional eight of its dirty, coal-fired power plants.   Reuters said that back in 2010, Germany committed to reducing emissions by 40% by 2020... and that German Chancellor Angela Merkel's government wants renewables to make up 40%-45% of power generation by 2025 and 50%-60% by 2035. That's an ambitious target for an industrialized nation.

 

 In their latest issue of Stansberry International, Porter and Brett covered the energy dilemma in Europe. Germany and the U.K. each have nine of the 30 dirtiest coal and lignite power plants in Europe, according to a recent study by Climate Action Network, a group of non-government organizations. Germany has four of the top five.

 

Across Europe, coal and lignite remain strong sources of fuel for power plants. Both are dirty from a CO2 emissions perspective... but they're also cheap. From the November issue of Stansberry International – out last week...

 

Countries like Spain and Germany have invested billions in solar and renewable energy. But solar power is expensive and inefficient to power the main grid.   The Institute for Energy Research reported that as of February this year, Spain suffered a $41 billion "rate deficit" caused by the government obliging utilities to buy renewables at higher prices than what they could charge consumers. That's about $850 per Spaniard. This means higher electricity prices and higher taxes to fund the gap.

 

 The World Nuclear Association estimates the cost of Germany attempting to replace nuclear power with renewables will be around €1 trillion. In the meantime, the country will increasingly rely on coal. Coal contributed to more than half of Germany's electricity last year – up from 43% in 2010.

 

With the exception of France, nuclear energy is taboo in most European countries. Germany has shut down a number of nuclear power plants over the past couple of years, and plans to close them all by 2022. This is in part due to the massive tsunami in Japan three years ago that led to a nuclear meltdown at the Fukushima power plant. From the November issue of Stansberry International...

 

German politicians have backed themselves into a corner with few options, perhaps inadvertently. Nevertheless, they now face some tough decisions on energy policy... They are ramping up coal consumption to produce energy. But they need to reduce carbon emissions.

 

 In their latest issue, Porter and Brett told readers why the recent activities in Europe will lead to more natural gas consumption across Europe. Over the coming years, they expect to see more countries use natural gas as a growing source of energy.

 

Porter has been bullish on all aspects of natural gas for years, including the production, liquefaction, transportation, storage, and distribution... among others. Porter likes that it's abundant and much cleaner than coal.

 

 In the March issue of Stansberry International, Porter and Brett recommended Spanish energy giant Gas Natural Fenosa, an integrated natural gas company. Subscribers are up nearly 20%... and collecting a near-4% dividend.

 

And in the November issue, – Porter and Brett recommend another energy giant. They said they couldn't remember the last time an international behemoth was trading so cheaply. It plays a critical role in Europe's energy dilemma. And as Brett and Porter point out, it just signed the deal of the decade – worth hundreds of billions of dollars.

 

Today, the stock trades below Porter and Brett's maximum buy price. If shares just returned to their normal historical valuation, the stock would double... But Porter and Brett believe the gains could be much more.

 

 You can learn more about a subscription to Stansberry International – which will give you access to Porter and Brett's latest pick – by clicking here.

 

 New 52-week highs (as of 11/21/14): Apple (AAPL), Deutsche X-trackers Harvest China A-Shares (ASHR), Berkshire Hathaway (BRK), Cisco (CSCO), Dollar General (DG), Express Scripts (ESRX), iShares Dow Jones U.S. Insurance Fund (IAK), Medtronic (MDT), 3M (MMM), Pepsico (PEP), PowerShares Buyback Achievers Fund (PKW), PowerShares QQQ Fund (QQQ), ProShares Ultra S&P 500 Fund (SSO), Cambria Shareholder Yield Fund (SYLD), Sysco (SYY), TC Pipelines (TCP), Travelers (TRV), Union Pacific (UNP), and W.R. Berkley (WRB).

 

 In today's mailbag, a subscriber shares his experience and thoughts on the commercial real estate market. As always, let us know what you're thinking at feedback@stansberryresearch.com.

 

 "Hi, Porter. Great column! Insightful, as always. In my primary area of wealth (real estate, although my day job is teaching Physics) I have observed a similar phenomenon. I bought a 72 unit apartment complex 8 or 9 years ago. The pro forma looked great using the 6.67% interest rate on the loan that seemed most prudent at the time, fixed for 5 years. I have subsequently tried to refinance the loan several times, but the lending standards have changed; unless I have a net worth of greater than the amount of the loan, I cannot find a lender willing to refinance my loan. The good news for me came after the end of the initial 5 year period, when the loan automatically reset at 5.67% due to the worldwide drop in interest rates, the maximum lifetime decrease according to the terms of the loan. The bad news was that ever since I have been competing with owners who have dramatically lower interest rates (in the 4% range), and since they have lower payments they are profitable with much lower rents than I can be.

 

"Because of this, 1) there is a perverse incentive in the MFH industry toward overbuilding; new buildings come with lower monthly payments, even if it costs more to build them than the older product currently on the market. 2) There is also a strong incentive to finance with the lowest possible interest rate in order to be able to compete; but, of course, these loans come on the shortest possible term loans, which exposes one to the vagaries of future inflation and concomitant increases in rates. But most important of all, 3) many borrowers are forced into purchasing with interest only loans. That is crazy!

 

"An apartment building will always decay, at least until the government writes a law overturning the laws of thermodynamics. The Second Law says that entropy increases in 3 situations: in the universe as a whole, in EVERY closed system, and in almost every open system (by the way, in open systems with energy input, the problem of entropy is usually exacerbated, contrary to the ignorant masses. That is one of the reasons your thesis about solar power is correct; but I digress). So many investors buy commercial investments with these interest only loans. Let's say that I do so for ten years. Now my property is 10 years older and has enormously costly issues, such as roofs that need to be replaced, plumbing that is aging, parking lots that are disintegrating, etc.

 

"The point is that the system pushes investors to buy a decaying asset with a loan that does not pay off the asset. After 30 years, the property SHOULD be worth less, but the government has done a good job until the last few years of inflating the real estate bubble to mask the stupidity and myopia of investors who buy with interest only. By the way, I hope I'm not stepping on the toes of all you folks at Stansberry, several of whom I have heard mention that they have plunged in the real estate market in recent years. If any of you have bought that way, it is a ticking time bomb; beware!

 

"I suspect I will be able to successfully refinance my property fairly soon, because I have now paid the loan down by about $400,000 in the 101 months I have made payments. My net worth is consequently increasing enough that I think I'll be able to get a loan soon. But if that loan had been interest only, I would most assuredly be doomed. The system is rigged for collapse, and every day more snowflakes accumulate. Thanks for the thought provoking education for the past several years." – Paid-up subscriber Timothy

 

Regards,

 

Sean Goldsmith

November 24, 2014