April 24, 2012 / 6:35 PM / 5 years ago

HOW TO PLAY IT-Betting on Germany despite Europe's pullback

NEW YORK, April 24 (Reuters) - Once again, concerns about Europe's debt problems are weighing on global stock markets.

The latest catalyst was a triple decker: the apparent collapse of the Dutch government; a victory by Socialist candidate Francois Hollande in the first round of the French presidential elections; and an unexpected drop in euro zone business in April, according to the Markit purchasing manager's index.

The European FTSEurofirst 300 index, a broad measure of European stock markets, fell 2.3 percent on Monday to its lowest level since mid-January, though it managed to recoup some losses on Tuesday.

The sell-off may be overblown, analysts said. Financial institutions are much healthier now than a year ago due to steps taken by the European Central Bank, which analysts said should lessen the chances of Europe's debt problems bleeding into the global economy. As a result, German companies, global dividend-paying stocks and emerging market debt may be smart bets now.

Here are suggestions on how to play the latest European-based sell-off:

Betting on Germany

The recent stock pullback may be an opportunity to pick up shares at more favorable prices, analysts said.

"The concern that we had last year was of an implosion of the euro-area financial system that would take everything else down with it, and that scenario is unlikely to recur this year." said Michael Hood, a market strategist at JP Morgan Asset Management. "The downside risks are almost bound to be less" because of the actions taken by the European Central Bank to stabilize the financial system, he added.

Hood remains relatively optimistic about the direction of the global economy. The U.S. labor and housing markets are gradually healing, he said, and the pace of growth in China should pick up in the second half of the year after having slowed to an 8.1 percent rate. Economists expect China's economy to grow by 8.4 percent over the rest of the year, according to a Reuters poll.

In the United States, he forecasts that the materials and the financials sectors will continue to gain through the end of the year. The financials sector of the S&P 500 is up 16 percent this year, the most of any sector, while the materials sector is up 7.7 percent.

In Europe, performance will continue to depend more on geography than sectors, he said.

"Germany has outperformed Europe in general by about 10 percentage points this year, and I think there's further room there," he said.

The iShares MSCI Germany Index (EWG) is one option for a play on German companies. The $2.9 billion fund charges 51 cents per $100 invested and yields 2.9 percent. Its top three holdings are Siemens AG, Basf SE and SAP AG.

The fund is up 21 percent over the year to date, making it the top-performing fund in its category, according to Morningstar data. The broad European Stoxx 50 index, by comparison, was down 3.1 percent for the year through Monday's close.

Buying on Dips

Other money managers are turning toward defensive stocks and emerging market bonds as a substitute for moving into cash.

Glenn Guard, the director of investment management at Campbell Wealth Management in Alexandria, Virginia, said his company is avoiding investing any new money in European indexes because he thinks the sell-off will continue. Instead, he is looking at global businesses that have a record of increasing their dividends such as Coca-Cola Co. and Procter & Gamble.

"Though it doesn't feel like it, the world economy is growing and these companies are going to participate in that growth," he said.

With a year-to-date gain of 5.3 percent through Monday, Coca-Cola stock has slightly underperformed the 8.7 percent gain in the broad Standard & Poor's 500 index. That may change, however, if the stock market's rally stalls and investors turn their attention to blue chips. Coca-Cola comes with a dividend yield of 2.8 percent and trades at a price-to-earnings ratio of 19.5.

Mark Lamkin, the head of Louisville, Kentucky-based Lamkin Wealth Management, expects concerns about Europe will lead to a 10 percent drop in the S&P 500 index. He is waiting for a further decline before adding to his positions in global industrial firms through the Industrial Select Sector SPDR (XLI).

Industrial Select, a $3 billion fund that charges 18 cents per $100 invested, focuses on companies in industries like aerospace, defense, transportation and industrial conglomerates. Its largest holdings are General Electric, United Parcel Service and United Technologies Corp. The fund is up 11.4 percent since the start of the year, according to Morningstar, and comes with a dividend yield of 2 percent.

"We're in the middle of a business expansion, and we're looking at companies like 3M that are gathering momentum that have global reach and sell more to businesses than consumers," Lamkin said.

Other money managers are turning to the bond market. Frank Fantozzi, president of Cleveland, Ohio-based Planned Financial Services, said many of his clients are moving toward emerging market and high-yielding corporate debt.

"If we get a bad employment numbers and you add that to Europe, then (stock market) volatility could spike," he said.

One popular ETF choice: the iShares JPMorgan USD Emerging Markets Bond (EMB), an ETF that holds only U.S.-dollar-denominated bonds in order to eliminate currency risks. The fund, which costs 60 cents per $100 invested, yields 4.7 percent. It is up 4.2 percent for the year, according to Morningstar.

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