COLUMN-European stocks beckon as EU turns around

Tue Jul 9, 2013 7:59am EDT

By John Wasik

CHICAGO, July 9 (Reuters) - Buried in a recent avalanche of anxiety over the Federal Reserve and U.S. bond and stock selloffs was continuing good news about European growth.

With euro zone growth expected to return in the second half of this year, buying opportunities abound after the recent global stock retreat, according to Standard & Poor's Capital IQ analyst Robert Quinn. He expects "fragile growth" by the end of this year as businesses start spending again.

The Continent is still a long way from safe-harbor territory, but its recovery may be on course. A reliable growth gauge known as the Markit's Flash Euro Zone Composite Purchasing Managers' Index rose this month to its highest level since March 2012, topping forecasts. In addition, the United States and the European Union on Monday began talks on a free-trade agreement that could boost American and E.U. gross domestic product by $100 billion annually.

If approved, the free-trade agreement would boost sales and profits of European companies. The two trading partners transacted nearly $650 billion in business last year alone.

Even a meager European recovery is positive news for investors. Unlike the Federal Reserve's recent announcement that it could begin winding down its bond-buying program as early as the end of this year, European Central Bank President Mario Draghi said on June 26 that the ECB's easing program exit is "distant." That policy may provide an underpinning for European growth.

THE BROAD BET

Although S&P's Quinn sees some sectors turning around faster than others - he's favoring banks, industrial goods and services - a well-rounded portfolio featuring large companies could provide the right kind of exposure for a buy-and-hold investor.

The iShares S&P Europe 350 Index is an exchange-traded fund that holds European-based global players like Nestle, HSBC Holdings, Novartis and BP Plc. The fund is up almost 20 percent through July 5 compared with about 19 percent for the MSCI EAFE Index. The fund charges 0.60 percent annually in expenses.

Holding a similar big-stock portfolio is the Vanguard FTSE Europe ETF, which owns Roche Holding AG, Royal Dutch Shell Plc and Vodafone Group. The Vanguard fund invests in a slightly different index than the iShares ETF and costs less: 0.12 percent annually. It's gained 20 percent over the past year.

RISKS REMAIN

Much needs to happen before the "all clear" siren sounds on Europe. The euro zone needs a centralized way of providing bailouts to members. Southern Europe is still struggling under austerity measures and debt loads. Unemployment is still oppressive in Spain and Greece.

There's also a bumpy road ahead this year for the largest euro zone countries. Still mired in a mild recession, the International Monetary Fund (IMF) predicts that France will grow 0.8 percent next year, rebounding from a 0.2 percent contraction this year. The IMF has cut in half its growth forecast for Germany this year - to 0.3 percent.

Another wild card is China, which is a big customer of European exporters. Investors are concerned that the world's second-largest economy may recede. The People's Bank of China has taken action to stem a credit crunch and is attempting to curb growth in the country's "shadow banking" sector.

Downturns or protracted growth in China or the United States would have a negative impact on Europe in a global economy.

That's why European stocks should be a relatively small part of your overall stock holdings - less than 10 percent of the total. While there are plenty of quality stocks from the continent at reasonable prices, it's still difficult to say when the darkest clouds will lift.

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