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How to Play a Rebound in European Stocks

By Jim Fink on September 6, 2011

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Despite the economic turmoil across the pond, pockets of the eurozone remain attractive for ETF investors.

– Yiannis Mostrous, Global ETF Profits

Back on July 21st, Eurozone finance ministers and the International Monetary Fund (IMF) agreed to fund a second huge bailout of Greece that would defer the Greek debt issue for at least a couple of years.

So why are Greece’s two-year notes yielding 50 percent? The reason is that the July bailout agreement can’t go into effect until it is approved by national parliaments and that hasn’t happened yet because of August vacations and some parliamentary opposition in Finland and Slovakia. German Chancellor Angel Merkel’s political party–the Christian Democratic Union–lost its fourth straight local election, this time in her home state of Mecklenburg-Western Pomerania. Investors have interpreted the loss as the electorate’s rejection of her push for more taxpayer money to fuel Eurozone bailouts. Meanwhile, Italy’s 10-year bonds fell for a record 11 straight trading days on news that Italy’s largest union is calling a nationwide strike. The strike is meant to pressure Italy’s parliament to reject Prime Minister’s Silvio Berlusconi’s plan for budget austerity–a program that’s needed to prevent a credit downgrade and a potential default.

What a mess! And the head of Germany’s state-owned development bank KfW Group didn’t help matters when he said that the situation today is “much more dramatic than in 2008.” The CEO of Deutsche Bank AB (NYSE: DB) piled on the panic by stating that many European banks would “obviously” fail if they were forced to write down their European sovereign debt exposure to their current market values. Eurozone finance ministers don’t meet again until Sept. 16, so we could be in for two more weeks of uncertainty. Finance officials from the G-7 (United States, Canada, Japan, Germany, France, Italy and Great Britain) will meet in France on Friday and Saturday of this week (Sept. 9-10) and hope to issue a statement that will calm markets. 

U.S. Economy Will Be Largely Unaffected by Europe’s Problems

The good news for U.S. investors is that Atlanta Federal Reserve President Dennis Lockhart recently said that U.S. banks’ exposure to European sovereign debt is “contained” and “should not have a large impact on the U.S. economy.”

Nevertheless, investor fears about indirect US bank exposure (i.e., debt holdings in European banks that themselves have direct sovereign debt exposure) caused the S&P 500 to reverse course mid-week and turn a 3.6 percent gain into a slight loss. The bearish clincher was Friday’s August employment report, which showed a much worse-than-expected net gain in jobs of zero, the first time since 1945 that the economy created no jobs. For good measure, jobs for June and July were revised down by a total of 58,000.

The employment number was actually not as bad as reported; it deducted 45,000 jobs because of the temporary two-week Verizon strike that has now concluded. Furthermore, some economists estimate that up to 30,000 additional jobs would have been added by related businesses were it not for the Verizon strike. This would have brought the total private sector job gain to 75,000, hardly a stellar number, but one that doesn’t signal a recession. 

The Economic Cycle Research Institute’s (ECRI) Weekly Leading Index fell for the third consecutive week to the lowest growth reading since November 2010. The 4.3 percent decline in growth is a bit worrisome, although it’s not yet pronounced enough to mark a recession. ECRI co-founder Lakshman Achuthan says that the US economy is on “thin ice.” Other economists aren’t too optimistic either.

Reasons to Be Bullish on the U.S. Stock Market

A few reasons remain, however, to support the view that a U.S. recession will be averted and/or stocks are good buys right now:

  • At its Sept. 20-21 meeting, the Federal Reserve is widely expected to implement a rebalancing of its balance sheet in “Operation Twist,” which would sell short-term fixed-income securities and use the cash to purchase longer-term securities. Although the absolute size of the Fed’s balance sheet would remain the same, Goldman Sachs estimates that the rate-reducing effect on longer-dated US Treasuries would be almost as significant (between 80 percent and 90 percent of the effect) as the effect the Fed’s $600 billion second round of quantitative easing (QE2) had on the US economy.
  • ADP jobs report for August showed a 91,000 gain. Economist Joel Prakken, who partners with ADP to produce the jobs report, told CNBC that the likelihood that the US is actually in recession is “really very small.”
  • Retail sales rose 4.4 percent in August, leading one economist to say that “the underlying pace for consumer spending continues to look good.”
  • The ISM manufacturing index for August came in better than expected at 50.6 percent, marking the 25th consecutive month of economic expansion.
  • Auto sales in August were up by double-digit percentages for all of the “big three” US auto manufacturers. According to the chief economist of insurer Nationwide: “the message here is that we’re not facing a double dip.”
  • Only 138 CEOs cut their companies’ profit forecasts in August, which is 38 percent lower than the August average of 221 CEOs. 
  • Wharton finance professor Jeremy Siegel says that stocks are cheap even if a recession were to occur and he’s a buyer right now.
  • The S&P 500 trades at only 12.8 times trailing 12-month earnings, the cheapest they have been since 1985.

What does this have to do with Europe? As Yiannis Mostrous, co-advisor of the market-beating Global ETF Profits investment service, points out:

Not only are the U.S. and EU economies connected by trade and finance, the U.S. economy is a barometer of European growth.

Best European ETFs

While the U.S. stock market looks good to me right now, the European stock market is primed for an even bigger rebound. Whereas U.S. stocks suffered their worst August in ten years, this past August marked the second-worst monthly decline for European stocks at any time in the last 25 years (only October 1987 was worse). As the saying goes, the further they fall, the higher they bounce. Below are a few ETFs that provide diversified exposure to European stocks:

European ETF

Expense Ratio

Top Holdings

Vanguard European (NYSE: VGK)

0.14%

Nestle (Other OTC: NSRGY.PK), HSBC Holdings (NYSE: HBC), Vodafone (NasdaqGS: VOD)

iShares MSCI Germany (NYSE: EWG)

0.53%

BASF SE (Other OTC: BASFY.PK), Daimler AG (Other OTC: DDAIF.PK), Bayer AG (Other OTC: BAYRY.PK)

iShares MSCI EMU Index (NYSE: EZU)

0.54%

Total SA (NYSE: TOT), Siemens AG (NYSE: SI), Telefonica SA (NYSE: TEF)

iShares S&P Europe 350 Index (NYSE: IEV)

0.60%

Novartis AG (NYSE: NVS), BP plc (NYSE: BP), Royal Dutch Shell plc (NYSE: RDS-A)

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