9/3/2013 9:30 PM ET|
4 reasons to invest in Europe -- really
As the US market loses strength, Europe's economies are in the early stages of a recovery, and investors are just starting to catch on. That makes these stocks and funds compelling buys.
Worried about U.S. stocks?
Then send some money into Europe -- European stocks, that is.
Sure, Europe has rallied strongly since I suggested it as a bold contrarian play a year ago because the experts thought it was about to blow up (see "5 stocks to buy on Europe's woes.") Euro stocks are up 16% since then.
But Europe is still a bargain, because many investors still have serious doubts about the continent. You can tell by the cheap stock valuations there, especially compared with U.S. stocks.
European economies are finally turning the corner -- giving us another reason to think the rally will continue.
Follow-through on economic strength, which I expect, will send euro stocks much higher over the next one to three years, and they will probably even outperform U.S. stocks. "Europe is appealing because it is unloved, under-owned and undervalued," says Raymond Vars, a portfolio manager with NorthRoad Capital Management.
So what to buy?
Money managers like Vars who are overweight Europe as a value play favor cyclical stocks such as WPP (WPPGY) in advertising; Total (TOT) in energy; Novartis (NVS) and Sanofi (SNY) in health care; heavily discounted banks such as BNP Paribas (BNPQY) and Intesa Sanpaolo (ISNPY); and cheap insurance giants such as ING Groep (ING) and Aegon (AEG).
For more diversified exposure, you can buy the mutual funds of the pros offering insights and names in this column, since their funds -- including NorthRoad International Fund (NRIEX), RidgeWorth International Equity Fund (STITX) and Advisory Research International Small Cap Value Fund (ADVIX) -- outperform competitors. Another option is European exchange-traded funds (ETFs), such as Vanguard FTSE Europe (VGK).
Before we explore the details of these stocks and a few others that are bargains, let's check out the four main reasons European stocks may do better than U.S. stocks in the future.
Reason No. 1: They're a lot cheaper
This might be the most convincing reason. A price-earnings (P/E) ratio using inflation-adjusted earnings from the prior 10 years, to smooth out ups and downs, stands at 13.5 for Europe, compared with 23.6 for the S&P 500($INX), points out Vars. That's an unusually broad gap on this standard measure of value. The two markets typically trade more in tandem.
One reason is that doubts still linger about the economic viability of Europe and the euro. I'll get to more on that in a second, but you can also think about the discount this way: Europe developed its own financial crisis a few years later than ours. So its economy and stocks are behind ours in terms of their recoveries.
That makes European stocks the type of bargain that U.S. stocks were back in 2010 or 2011, says Cindy Sweeting, the director of portfolio management at Templeton Global Equity Group. European stocks are so cheap, Sweeting describes Europe as a "once-in-a-generation buying opportunity" right now, and a better place to shop for bargains than the U.S. or emerging markets.
Reason No. 2: Postal code discount
Many European companies carry what Sweeting calls a "discount for domicile." This means investors are wrongly shunning big European companies because the home office has a European postal code, even though they do much of their business outside of the continent -- in regions with better growth including the United States or emerging markets.
Reason No. 3: European economies have turned the corner
In the second quarter, the eurozone returned to GDP growth for the first time since early 2011. Growth came in at 1.1%, and even troubled Portugal showed strength. The economies of Spain, Italy and Greece contracted, though less so than in the first quarter.
Now we see follow-through. The region's purchasing managers' index, a measure of business sentiment, rose above 50 for August and July, for the first time since January 2012. Anything above 50 is considered expansionary.
"The bailouts are working," says Marco Priani, a portfolio manager for the Advisory Research International Small Cap Value Fund, which outperformed competitors by 1.8 percentage points over the past three years. In the bailouts, European authorities and its central bank have provided funds to support troubled banks in struggling countries, and pledged to buy their government bonds to keep them from going back into freefall on worries that Europe will implode. The moves seem to have shored up confidence, contributing to improvement in economic strength. "Even though the economic picture is not as rosy as in the United States, that is more than baked into the multiples," says Priani.
Investors don't trust the rebound yet. But that is often the best time to buy -- when there's a trend change that people don't trust. "We have gotten past the worst of it in Europe," says Vars. "It doesn't mean that it is all over, but when you get past the worst of it is often a good time to invest."
After all, if you wait for trend reversal to be 100% confirmed, it will already be priced in to stocks. It will be too late.
Reason No. 4: No euro divorce in store
In late August, German Finance Minister Wolfgang Schaeuble warned that Greece once again needs a bigger bailout to shore up its finances. "A year ago, that would have caused problems in the markets," says Priani. But that didn't happen this time around because it's become clear that Europe will do what it takes to maintain the European Union.
"As long as the overall direction is towards maintaining the union, we will see less extreme downturns in the market," says Jim Kee, the president and chief economist for South Texas Money Management.
Sweeting expects progress in the coming months on changes necessary to keep the union together -- such as pension reforms to curtail national debt growth and labor market reforms to boost growth, among others.
Now let's look at some cheap stocks that will benefit as Europe makes progress on reform and its overall economy gets stronger.
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