When we heard that the CFA Institute annual conference was in Zurich this year, we decided this was the opportunity we needed to research European economies we had been recently considering as investment prospects. Specifically, this would give us the chance to make observations that could only be made in person. At Cornerstone, we usually make investment decisions using quantitative and qualitative resources based on our research tools; but in this case, we thought it was appropriate to see for ourselves…
There were several reasons we considered this trip: some to do with decisions being made in the United States, while others were associated with the neglected economies of Europe. In particular, we have been concerned about potential weakness in the dollar as it seems that both US consumers and the US government cannot spend enough. All the while, these dollars we use to spend are being loaned to us, in part, by other nations. At the same time, there are some European economies where investment opportunities have been neglected, yet domestic demand is beginning to accelerate, meaning there may be opportunity.
Our idea centered on the re-emergence of the German economy and the effect this would have on neighboring countries. In order to cover the territory we needed to, we divided the trip into three phases: Mark’s research, the CFA conference, and Scott’s research. This allowed us to each focus on previous experiences and strengths while only having the office closed for four business days.
During the first phase, Mark, Lynn, and Pape (yes, we traveled with a 4 month old) landed in Zurich and rented a car to travel up the Rhine with the ultimate goal of reaching Amsterdam. While in Germany, Mark had the opportunity to attend a Rotary meeting in the city of Mainz, which allowed for interaction with members of the city’s business community. Contrary to popular opinion, all Germans are not Socialists, as the individuals he met were just as concerned about profitability as anyone in our country.
The Davidsons spent two days in Amsterdam, and Mark had meetings with investment managers both days; this was particularly useful, given that the Dutch have been global investment managers for a long time and have always had a disproportionate impact on the financial world relative to their domestic economy. From Holland, they traveled to Antwerp through Rotterdam (in some of the worst traffic they had ever been in, another useful observation) for a visit with a Belgian investment manager. During these meetings, the Europeans confirmed that the US Dollar was dependent on the “kindness of strangers” and that domestic demand in the Eurozone was increasing. On the way back to Zurich, they drove through the northeastern region of France where they were very warmly received.
During our time at the conference, we had the opportunity to interact with investment managers from all over the world (and discuss some of our ideas with individuals from each of our target countries). For the most part, we found the Germans to be especially pessimistic about the prospects for recovery in their country; interestingly, the investment professionals we had spoken to in other countries did not share this pessimism. It was also during this time that we really coalesced our long-term bullishness on the US economy in spite of some considerable entitlement programs we will have to deal with in the coming years. One other interesting fact: of the 400 conference participants from the United States, most were there on “vacation” and extending their stay in Europe by visiting Paris or Vienna. We did not encounter anyone else who specifically indicated they were conducting investment management research.
As we have mentioned, Germany is the key to our investment idea. After the conference, Scott and Robyn spent another four days in country visiting Stuttgart and Jena (in the former Communist East Germany). Stuttgart, home to the big German auto manufacturers, was as you would expect: big, clean, and busy. The day before a national holiday, there were lots of shoppers in the streets with bags full of goods. This flies in the face of the Western convention that the German economy is sluggish because of the German consumer. The time in Jena was most revealing as this university town (the most Ph.Ds per capita of anyplace in Germany) is an example of what the East could be after reunification. All over the former East Germany, firms are locating factories and research facilities where there is a highly educated population with a desire to achieve. In the recent past, Germany has struggled with its national identity: first reunification and then the Euro. Germans have proven they can compete with any economy in the world, and now they are starting to believe it.
We are entering a time of synchronized global growth as growth rates of most regions of the world achieve parity with one another. This means that Europe’s growth rate will likely increase in the near-term, while that of the United States will decrease. In addition, there will be a considerable trend towards international diversification, both within US portfolios and by major petroleum producing nations. Currently, the allocation within the US is heavily domestic while a considerable amount of wealth from oil nations finds its way to our capital markets as well. This trend will result in increased demand for European companies as more money chases a limited supply of shares (which will foster capital market growth in Europe as well).
At the end of our trip, the assessment is that Germany is akin to a mid-cycle stock. The output of this nation (the world’s largest exporter) is not an early-cycle good like a commodity, but rather, goods with value added through complex specialization. Germany remains an industrial society, and as the rest of Europe and the world demand their goods, German domestic demand should also rise. As German domestic demand and output grow, it will positively affect marketing, distribution, and finance nations such as the Netherlands and Belgium. This is also likely to provide a positive impact to Switzerland as demand for pharmaceuticals and luxury goods increases with increased wealth in these countries.
Finally, for US investors all is not lost. The United States has considerable advantages in the global marketplace. Specifically, risk taking, innovation, and creativity are rewarded in our society. In addition, we have highly flexible labor markets and developed capital markets that make our marketplace the most dynamic in the world. These are considerable advantages and explain why the United States will matter in world markets for years to come.
Switzerland, Belgium, Amsterdam, and Germany, May 2006
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