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ETFs: Playing Europe's Rebound

Stocks in this article: RBS LYG

By Michael Johnston of ETF

The turmoil that has plagued U.S. equity markets over the last two years will no doubt have several lasting effects. Regulation of the financial sector has been permanently changed. The role of the government in the private sector has been escalated to levels never before imagined. And the wisdom of allocating nearly all of one's portfolio to U.S. securities has come under heavy fire.

As U.S. investors look to diversify their holdings beyond their borders, many are looking to Asia, where some countries have already begun raising interest rates, to drive a sustained recovery. But a growing number of investors believe European stocks are also poised to rise rapidly over the next two years amid a recovering economy, increasing corporate earnings and a favorable monetary policy.

In The Wall Street Journal, Dave Kansas outlines a fairly straightforward investment case for Europe:

  • Average price-to-earnings ratios are at about 16, down from a historical level in the low 20s in the 1990s.
  • Stocks are about 15% below their long-term average price-to-book ratio.
  • Dividend yields relative to government bond yields remain attractive.

Moreover, while Asia's swift recovery is likely to result in increased interest rates in the near term, Europe faces strong headwinds that are likely to keep rates depressed for the next several quarters, a factor that could further stimulate growth.

Uneven Growth

Despite geographic proximity and a common currency, the fates of many European economies have been remarkably independent of each other. Spain, once home to a booming construction industry, has seen its economy collapse and could experience unemployment as high as 25% in coming years. Ireland has been another laggard, as the "Celtic Tiger," spurred by low corporate taxes and improved educational infrastructure, now seems far less fierce. Even the U.K. faces significant risks, as large government stakes in financial giants Royal Bank of Scotland (RBS) and Lloyds Banking Group (LYG) make investors a bit uneasy.

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