Eurozone Exits Recession: Time to Buy EU Stocks?

Eurozone Exits Recession: Time to Buy EU Stocks?

iStockphoto/The Fiscal Times

Europe and economic growth: It has been so long since the two concepts were linked together that you might have done a double take at the news last week that gross domestic product in the Eurozone rose 0.3 percent in the second quarter over the first quarter. The gain, which follows six straight quarters in which the 17-nation region saw its GDP decline, is largely due to trends in Germany and France, however – the more robust “core” of the region.

While the news comes as a pleasant, if not entirely unexpected, turn to the economic gloom and doom that has shadowed Europe for years, it doesn’t mean the region is out of the woods yet. “Fragile” is a word that is beginning to be tossed around to describe what is taking place, and even if the Eurozone can repeat its second-quarter GDP gain over the coming three quarters, that still adds up to annual GDP growth of just north of 1 percent. That’s a far cry from the 2 percent to 3 percent growth that some economists have suggested would be needed in order for the Eurozone to achieve a more meaningful, lasting recovery.


Europe’s recession may officially be over, but large swaths of the region are still struggling. True, the contraction that Greece, Spain and Italy witnessed in the second quarter was more muted than it had been in recent quarters, but those economies still aren’t growing, and unemployment in parts of the so-called periphery is close to double the already-high 12.1 percent Eurozone-wide level.

So, what’s an investor to do? Many are hunting for places to park their cash as they abandon emerging markets and fixed income, the first because of the lackluster performance and the risk; the latter as they anticipate more losses as the Federal Reserve seemingly moves closer to abandoning its quantitative easing programs with every week that passes.

Compared to those choices, Europe looks downright tempting, offering investors a second chance at playing a stock market recovery. While European stocks have traded higher this year, especially in the past two months, the gain of 7.6 percent by the Dow Jones Euro Stoxx 50 is less than half of the S&P 500 index’s year-to-date performance. The relative valuations also look enticing: The S&P 500 now trades at about 15 times projected earnings as the United States economy makes its way through its third straight year of economic growth. In contrast, the Euro Stoxx 50 trades for only about 12 times forward earnings.

Nor is it just the broad GDP data – which are backward-looking and subject to frequent revisions – that already have caused institutional investors to shift more and more of their cash into Eurozone equities. The region’s industrial production jumped 0.7 percent in June, a big turnaround from the decline reported for May. In Germany, investor sentiment rose an impressive 5.7 points to 42 points, much better than the 40 points that economists had forecast. No wonder that European stocks had been rallying even before the GDP came out last Wednesday. Europe is cheaper than the United States, and the headwinds facing the region seem to be abating, at least for now.

Still, it’s one thing for fund managers focused on Europe to shift their assets into stocks likely to benefit from domestic growth, such as banks, telecommunications companies and domestic or regional retailers. Those money managers confine their attention to the region and right now the only decision they need to make correctly is timing a bet on an economic recovery. Similarly, investment managers running international funds – whose task, in many cases, is to decide which parts of the world to over- or underweight at any given point in time – are souring on emerging markets and cautious of the story in Japan, where the initial buzz surrounding “Abenomics” has faded somewhat and markets are waiting to see real reforms.

Before you rush out to join the party, though, you may want to ponder the best way to play this apparent value story. Prudence suggests keeping an eye on countries and companies that grow along with the global economy and aren’t solely reliant on domestic improvement. That means largely shunning companies in Italy and Spain and focusing instead on those in the “core,” in France and Germany. Some have suggested emphasizing Europe’s luxury retailing sector, but that game may be at an end by now. LVMH Moet Hennessey Louis Vuitton, for instance, trades at 21 times trailing earnings and just reported a decline in profits in spite of higher revenues from its still-rising number of retail outlets.

One of the most interesting sectors might be Europe’s automotive industry. It has the kind of exposure to the broad global economy that may provide a cushion in the event that Europe’s growth stalls or that policymakers fail to resolve the problems that contributed to the region’s current plight. Moreover, many stocks in the group are less pricey right now than are other companies with a global tilt: Daimler recently traded at 8.7 times trailing earnings, BMW for 9.4 times and tire-maker Continental AG for 11.6 times.

Given that institutional money managers are now eyeing European opportunities with greater interest, another positive economic or political surprise or two may be all it takes for them to suddenly up their bets on the region. That, in turn, could trigger a fresh rally, as investors hunting for value jump off the fence and speculators rush not to miss a great momentum play. Whether or not you decide to be among them, it’s no longer quite as easy to overlook Europe as an investment option.