Sell Madrid, buy Berlin

For some years now it has been fashionable for fund managers investing in Europe to consider the entire Eurozone as one great big market divided up not by national boundaries but by industry. They see the choice not as between investing in Spain or in Switzerland but between, say, pharmaceuticals and retail. And when asked if Europe is expensive or cheap they won’t tell you that one country is cheaper than another; they’ll tell you the price-earnings ratio for the zone as a whole. This all sounds very modern and clever but I wonder if it really makes sense. It is becoming increasingly clear to me that they might actually be better to look at investing in Europe the old-fashioned way, country by country.

Seen as a whole, Europe looks like a perfectly good place to put your money. It grew 2.7 per cent last year and most forecasters have it doing much the same this year — better than either the US or the UK are likely to do — while the average price-earnings ratio across the zone is a respectable 14 times and dividend yields are rising nicely. But it’s also clear that the fortunes of Europe’s national economies have diverged significantly. Take Spain: low interest rates have allowed household debt to rise by over 250 per cent in the last ten years and have fuelled a massive and highly speculative property bubble: property and construction now make up around 18 per cent of GDP. This has been less of an economic miracle than a ‘debt-fuelled binge’, as one analyst put it.

And binge is now very obviously turning to hangover: the recent vicious sell-off in Spanish property and bank stocks was probably just the beginning of something much nastier. As rates rise and house prices keep dropping, expect to see consumption start falling off, too — with predictable effects on corporate profitability. ‘You’d need your head examined,’ Simon Pickard, manager of the Argos Greater Europe Fund, told me last week, ‘to be thinking about investing in Spain at the moment.’

Pickard has similarly harsh things to say about anyone thinking of putting a little money into the Irish ‘economic miracle’. So far there has been no sudden shock to the Irish market as there has been in Spain, but things are just as bad there. Why would you want to invest in a country where too-low interest rates have driven a housing bubble more dramatic even than those on the Costas and in Notting Hill; where, according to Irish property website Daft.ie, asking prices in parts of Dublin have fallen 10 per cent in the last year; and where a clearly unsustainable construction boom accounts for 25 per cent of GDP? You wouldn’t.

But just a few borders away there is one country that stands out as a fabulous investment prospect — Germany. Not long ago Germany had the lowest economic growth in the eurozone. Now it has the highest. It is one of the few countries to have achieved some really major restructuring while rates have been low: German unit labour costs have actually fallen by more than 2 per cent in the last four years and according to Stephen Roach of Morgan Stanley around 40 per cent of the nation’s workforce are now ‘flexi-workers’ (part-time or freelance contract workers). At the same time exports have surged —despite the strong euro — and Germany runs a good current-account surplus. Confidence and consumption are both rising steadily across the country and best of all — unlike those in the UK and the US — neither German companies nor German consumers have much debt. Unlike Spain, where contraction is more likely, there’s plenty of scope for further growth. Better still, not all of that growth is yet reflected in stock prices.

Given all this I don’t think I really want to be invested pan-Europe on a sector-led basis, but I do think I want to be invested in Germany. I may even want to buy a house there. There’s been a lot of talk about a Berlin property boom in the last year: it isn’t happening fast yet, but prices, having barely budged for a decade, are starting to rise. So much so that even despite my long-term suspicion of property investing, I quite like the sound of it, particularly because the Germans themselves think a property boom in their country so very unlikely. When I was last in Berlin in December, I asked our hotel receptionist what she thought about buying houses. ‘Oh,’ she said, ‘you don’t want to do that. The market is very bad. Much better to rent.’ That’s the kind of response you would have had from most people in Britain in the depth of our last property recession back in the early 1990s. And look what happened next. I’ve been thinking about Berlin ever since.

Merryn Somerset Webb edits Money Week.