COLUMN-Don't let Russia scare you from euro zone stocks

Mon Apr 28, 2014 3:19pm EDT

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)

By John Wasik

CHICAGO, April 28 (Reuters) - Although it's easy to get distracted by the turmoil in Ukraine, the trickle of economic growth in Western Europe continues to boost euro zone stocks and batter Russian companies. Multinational Western European stocks should continue to be core holdings in your portfolio.

Things are looking rosier in the countries clobbered the hardest by the 2008 credit meltdown. As of April 25, the Italy FTSE MIB Index is up 13 percent this year, followed by a 12 percent gain in Portugal, almost 8 percent run-up in Ireland, a 5 percent increase in Greece and 4 percent recovery in Spain.

Among the negatives: Unemployment, deflation and tight credit continue to be problems in these countries, even if they are gaining ground on repairing their fractured banking systems. Also, stock markets in The Netherlands and Germany are down slightly this year (through April 25).

Independent of the Russian turmoil, there are concerns about deflation in the euro zone and a strong euro. European Central Bank President Mario Draghi said on April 24 that weaker inflation could trigger a round of asset buying by the bank. The rising euro also has the rapt attention of central bankers.

"The euro is too high," former ECB president Jean-Claude Trichet said on April 23 in Chicago while speaking at the Chicago Council on Foreign Affairs. Troubled by weak economic growth in central Europe, Trichet noted "clearly we need to elevate growth potential through structural reforms."

A strong euro relative to the dollar will make European exports less attractive and non-euro zone imports to the continent cheaper. That could hobble the weak recovery there. Yet if euro zone countries and the ECB can successfully navigate deflation and re-ignite growth, the picture looks much brighter for the continent.

To balance the bad and the good, you can pick a low-cost ETF that focuses on the companies leading the way toward growth and stability.

The Vanguard European Stock Index ETF holds a basket of leading continental stocks with global operations like Nestle SA, Roche Holdings AG and Royal Dutch Shell PLC. The Vanguard fund is up nearly 23 percent for the past 12 months through April 25 and has gained 2 percent year to date. The fund charges 0.12 percent in annual management expenses.

A similar fund, the iShares MSCI EMU Index, is up 28 percent for the year through April 25 and 2 percent year to date. Its top three holdings include Total SA, Sanofi and Bayer AG. It costs 0.50 percent annually in management expenses.

THE WEAK LINK

Despite the continued hope of a broad-based Western European recovery, investors need to be aware that the situation between Russia and Ukraine puts many multi-nationals in Western Europe in a precarious position. Natural resources are a major concern. The region imports some 30 percent of its natural gas from Russia. Tensions particularly impact Germany because of its heavy reliance on Russian natural gas.

And some European energy companies are intricately involved - BP PLC owns a stake in Russian state-owned oil company Rosneft, for example.

Sanctions will also take a bite. The European Union is considering restricting transactions with Crimean-based banks and other targeted sanctions. The U.S. announced a new round of curbs against Russia today. Yet it remains to be seen whether the European Union will seriously endanger its energy relationship with Russia through tougher sanctions.

But the real turmoil is in Moscow's stock market. As one of the "BRIC" countries - along with Brazil, India and China - spotlighted by investors as a highly coveted developing economy with high growth, Russia's economic expansion has nearly evaporated.

Russian debt was downgraded to near-junk status by Standard and Poor's on Friday and the country's central bank raised interest rates. Russia's growth may range from 0.5 percent to zero this year as capital flees the country and the rouble comes under increasing attack.

Investor money flowing into the leading Russian stock exchange-traded fund has all but halted. The Market Vectors Russia ETF holds top Russian companies like Gazprom OAO , Lukoil Company ADR and Sberbank Rossii OAO . The fund is down 15 percent for 12 months through April 25 and off almost 25 percent year to date.

The Market Vector's ETF's performance has been as challenging and volatile as a Russian winter. After losing 74 percent in 2008, it gained nearly 140 percent and 22 percent in 2009 and 2010. It lost 28 percent in 2011, then gained 15 percent in 2012, and then lost again in 2013 to the tune of about 1 percent. So far in 2014, it's down 17 percent.

While Russian energy stocks - and investors - will continue to see heightened volatility, a diplomatic solution could calm the tumult. In the interim, it's probably best to stay away from Russian stocks and embrace the larger narrative of recovery in Central Europe. (Follow us @ReutersMoney or here Editing by Beth Pinsker and Chizu Nomiyama)

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