Maybe Europe's fifth bailout, this time with Cyprus, isn't a charm after all.
ETFs linked to stocks in Italy (NYSEARCA:EWI) and Spain (NYSEARCA:EWP) got clobbered today. In U.S. trading, EWI 4.06% fell while EWP dropped 4.70%.
Now that European stocks have had a jolt, certain prognosticators are making the bold claim that "European stocks are oversold." Are they right?
What is "Oversold?" Before we can understand if European stocks are oversold, we must first define what oversold means.
Investopedia puts it this way:
"Oversold is a condition in which the price of an underlying asset has fallen sharply, and to a level below which its true value resides. This condition is usually a result of market overreaction or panic selling."
Currently, banking/financial stocks represent almost 30% of the iShares MSCI Italy ETF and 40% of the iShares MSCI Spain ETF. To be truly undervalued because of oversold conditions, an investor must first be convinced that Italian and Spanish banks are properly valued by today's equity market. What's an accurate valuation for stocks without massive monetary stimulus behind them? What's the proper valuation of insolvent banks?*
History shows us that Mr. Market has a special knack for miscalculating equity valuations.
Uncovering Performance What about the performance of European equities? Do they resemble oversold conditions?
To be oversold would actually suggest that European stocks have been badly beaten up - much like the time when Jack Dempsey put down Jess Willard seven times in the first round. Is that the case?
Over the past year, the Vanguard MSCI Europe ETF (NYSEARCA:VGK) a broad measure of European stocks hasn't suffered - but rather gained 11.05%. And even with Europe's latest circus in Cyprus, VGK still has a 0.88% year-to-date gain. Furthermore, VGK's share price trades above closely watched technical levels like the 200 day moving average. If you believe this is the sort of price action that describes oversold, you're drinking Kool-Aid.
Similarly, stocks in individual countries like Germany (NYSEARCA:EWG) and France (NYSEARCA:EWQ) have recorded double digit one-year gains. Even stocks in deeply troubled places like Ireland (NYSEARCA:EIRL) and Spain have posted yearly gains. EIRL alone has surged more than 24%! Let the discerning reader decide for himself or herself if that's the tell-tale sign of oversold territory.
Summary Don't be hoodwinked into believing European assets are oversold. Based upon sheer valuations and recent performance, oversold hardly describes stocks or ETFs linked to securities prices in this region.
Prudent investors and traders have been given ample chances to get out of publicly traded zombies while the gettin' is still good. They just have to be smart enough to decipher between propaganda and truth.
If there's two things you remember in our discussion of oversold, let it be this:
1) Oversold assets can become even more oversold during extreme markets.
2) Oversold never applies to insolvent bank, companies, or governments. (Just ask the poor saps holding "Bank of Cyprus" equity positions.)
Through a detailed analysis of valuations, sentiment readings, technical indicators, and historical parallels, the ETF Profit Strategy Newsletter evaluates financial markets. The brand new April issue includes a detailed short, mid and long-term forecast for stocks along with corresponding profit strategies.
*Just days before it collapsed, Lehman Brothers, according to many financial experts was "oversold" and "undervalued."