Why Europe's Equities Are Worth Cheering For

By Aaron Levitt | June 10, 2014 AAA

If the financial crisis hit the United States like a ton of bricks, it hit Europe like a bomb. Bad debt, austerity and recession hammered much of the Eurozone. Since then, Europe has been trying to pick up the pieces with various bailouts and easing measures designed to stimulate growth. So far those efforts have been somewhat successful. But with growth still stagnant in some areas, the European Central Bank (ECB) recently pulled out the big guns.

The ECB's recent policy changes could prove to be the most significant catalyst in some time to load up on European equities.

Whatever It Takes

One of the nasty side effects of low or zero economic growth is the threat of deflation. Deflation is exactly what kept Japan’s economy is the basement for the last twenty or so years. In order to combat this potentially serious problem, ECB Chairman Mario Draghi unveiled an unprecedented round of measures designed to fight deflation and stimulate growth.

That includes cutting benchmark interest rates to a new historic low of 0.15%, as well as a central bank first: cutting the deposit rate from 0% to -0.1%. This basically means banks will have to pay to deposit money with the ECB. The idea is simple: rather than lose money by hoarding cash, banks will be forced to do something with it. The hope is that banks will lend it out to businesses and retail clients for capital projects and spending. The trickle-down effect is that banks may reduce or eliminate the interest rate they pay depositors. Some analysts have even postulated that banks could begin charging customers to hold their cash. If that happens, individuals will be tempted to spend rather than save.

At the same time, Draghi opened up a €400-billion ($542 billion) swap line tied to bank lending in order to make it even easier for banks to borrow from the ECB. Additionally, the ECB has begun mulling over a serious of bond and asset-backed security (ABS) purchases similar to what the United States has been doing. This new round of easing should increase the money supply, drive down the strengthening euro currency and help drive economic gains.

It should boost stock and other asset prices.

As we’ve seen here in the U.S. and in Japan, stimulus measures do wonders for stock prices. Europe should prove no different. And despite hitting six-year highs, European equities are still cheaper than their developed market counterparts. The STOXX Europe 600 index can be had for a 3.25% dividend and a P/E of 15. That’s versus a P/E of 17 and a yield of just 1.81% for the S&P 500. (For related reading, see Stocks And ETFs For An Undervalued Europe)

Still Time To Add Europe

Given the size and focus of the ECB’s recent measures, investors may want to consider adding Europe to a portfolio. A prime way to do that is through the Vanguard European Stock Index Fund ETF (VGK). Like all of Vanguards products, VGK charges an ultra-cheap 0.12% in expenses. VGK tracks 504 different European firms, including stalwarts like Royal Dutch Shell (RDS-A, RDS-B) and Nestlé.

Overall, VGK is spilt 50/50 in terms of Eurozone and non-Eurozone companies, making it a great play for all of Europe’s new success. Another broad option is the SPDR EURO STOXX 50 (FEZ). FEZ focuses on the 50-largest European companies.

However, the biggest winners could be those firms located in nations that use the euro currency. Nation’s that are heavy exporters, such as Germany and the Netherlands, will benefit from the falling currency as their goods become cheaper abroad. Both the iShares MSCI Germany ETF (EWG) and iShares MSCI Netherlands ETF (EWN) allow investors to bet on these nations, while the WisdomTree Europe Hedged Equity Fund (HEDJ) uses currency swaps to take the euro out of the equation. HEDJ focuses its portfolio on those firms/nations that benefit from exporting. Top holdings include car manufacturer Daimler AG and consumer products giant Unilever (UL).

Finally, an interesting bet could be commercial real estate in Europe. Real estate prices are still very cheap compared to the U.S. but could rise as banks and investors flee the negative interest rates. The iShares Europe Developed Real Estate ETF (IFEU) is the way to play it. (For related reading, see 3 Winners If Europe Recovers)

The Bottom Line

The European Central Bank’s plan to cut rates and boost easing should light a fire under European equities and assets. For investors, the time to buy could be now.

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