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Why it's time to revisit European stocks

Published August 26, 2013 9:06 am

This is an archived article that was published on sltrib.com in 2013, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.

It's time for U.S. investors to revisit Europe.

Last summer, much of the continent was mired in recession and the euro currency looked like a failed experiment.

Now, Europe is healing. The 17 countries that use the euro posted economic growth of 0.3 percent from April to June compared with the previous quarter, the first expansion since late 2011. Industrial production is up, consumer spending is stable and stock markets are rising as people and businesses gain confidence.

Fund managers and market strategists say the last several months of better economic news and higher stock prices could signal the start a long-term rally for the continent.

"There are now clear signs that Europe is turning," says Jurrien Timmer, a portfolio manager at Fidelity Investments. Timmer recommends that investors move part of their U.S. investments into Europe.

In France, the CAC 40 stock index has risen 12 percent this year. Germany's DAX index is up 11 percent. Even more troubled economies like Spain and Italy aren't discouraging investors: Italy's FTSE MIB has climbed 7 percent and Spain's IBEX is up 6 percent.

European stocks appear to be less expensive than their U.S. counterparts, based on their price-earnings ratio, or P/E. Low P/Es signal that stocks are cheap relative to their earnings; high ones signal they are expensive.

The Stoxx Euro 600, Europe's equivalent of the Standard & Poor's 500 index, is trading at 13.1 times earnings over the next 12 months. That is slightly cheaper than the 14.1 times for the S&P 500.

Europe's nascent recovery can be traced back to a year ago. On July 26, 2012, European Central Bank President Mario Draghi pledged to do "whatever it takes" to save the currency union. Later, the ECB calmed fears of state bankruptcies in countries like Spain and Italy by promising to buy back government debt, if needed.

The improving fortunes of the eurozone can be seen in the borrowing costs of governments. The yield on Spain's 10-year bond, for example, is now 4.44 percent, down from 6.83 percent at the end of last August.

"Even this slight stabilization will help lead to renewed confidence in the eurozone," says Sean Lynch, global investment strategist for Wells Fargo Private Bank.

Europe's recovery is still patchy, but enough encouraging trends have emerged.

France exited its 18-month recession last quarter. Germany's economy, Europe's biggest, grew at a 0.7 percent annual rate, more than economists expected. Investor confidence there also hit a six-month high in August, according to the Centre for European Economic Research.

And while Spain's unemployment rate is 26.3 percent and its economy contracted by 0.1 percent in the second quarter, unemployment is at a five-month low. Economists expect Spain to pull out of its recession by year-end.

"The news out of Europe is encouraging," Lynch says. "It's too early to ring the 'all-clear' button, though."

In a conference call with investors on Aug. 14, Cisco CEO John Chambers said that business across Europe, particularly Britain and Northern Europe, was showing "very positive progress."

"We remain cautious, however, given the instability of the southern region," Chambers said.

That compares with a more skeptical view last month from McDonald's CEO Donald Thomson, who said the European economy had not yet turned the corner.

"I think the economists may be a bit ahead of themselves," Thomson said. "Some markets may have bottomed out. I would tell you some of the larger markets are still having some challenges."

Liz Ann Sonders, chief investment strategist at Charles Schwab, says Europe looks attractive partly because the economy still has challenges.

"The stock market is a leading indicator. It moves before the economic data catches up with it," Sonders says. March 2009, for example, was a good time to get into U.S. stocks, she says, even though things were "terrible economically."

The market was at its recession low back then and stocks were cheap. The S&P 500 has climbed 146 percent since then, helped by a recovery in the employment and housing markets, and the Federal Reserve's stimulus program. This year alone, the index is up 17 percent.

While Sonders believes investors should continue to focus on the U.S. stock market, Schwab has an "outperform" rating on European stocks.

Still, it's probably too early for risk-averse investors to put money into Europe, says Alberto Gallo, head of European macro credit research for the Royal Bank of Scotland Group PLC.

If people want to invest there, they should focus on corporate or high-yield bonds from the healthier eurozone countries such as Germany and France, Gallo says.

"The large institutional investors are not coming back to the eurozone's (struggling) countries yet," Gallo say. "The interest has been mainly (from) hedge funds. The institutional investors still see parts of Europe as too risky."