An Anti-Bubble In Europe?

September 25, 2008

How the current financial status is affecting a few markets across the pond—more "Anti Bubbles"?

In an article that appeared in this site last month, Rob Arnott and John West describe the current situation in several markets as an "Anti Bubble." The definition of Anti Bubble, according to Arnott and West, is "a market in which valuations fall below levels that any reasonable scenario would justify." Arnott and West bring as their primary example the financial sector in the USA.

The recent turmoil in Wall Street makes it hard to judge whether their example is a good one, but the observation in general—that prices may be going down too much due to panic—seems reasonable. An interesting phenomenon of the current crisis is that, although its sources are in the USA, its side effects on other countries are much stronger.

Let's take a tour of Europe, starting with Spain. (We'll be using U.S.-based ETFs for our analysis, although the analysis could equally apply to European-based funds as well).   


Table: EWP (follows the MSCI Spain index)


EWP is an ETF that follows the iShares MSCI Spain index. In the period between October 31, 2007 and August 31, 2008, the price of EWP went down by more than 23%. Its average P/E ratio decreased, in the same period, from 16.4 to 10, a drop of 39% (see the Appendix for the methodology of the calculations).

Is this significant loss of value supported by the index fundamentals? Apparently not. The average profit of the companies that are included in the index increased by more than 25%, and the average ROE went up from 23% to 25%.

So, is the Spanish index such a bargain now? 

One may argue that the fundamentals reflect history, and investors are pricing a very gloomy future.  After all, the Spanish index is highly exposed to the financial sector (about 40%) which can suffer from both the financial crisis in America and from the local troubles in the housing market.


Table: Sectorial breakdown of MSCI Spain Index


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