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European Stocks Rebound as Stability Returns

I had seen some interpret the rising ECB borrowing from Spanish (and other) banks as an indicator of financial stress, but the simple explanation I received from an accomplished institutional investor seems a lot more plausible: "I would just add that the banks in Europe are making a lot of money borrowing at 1% (3-year loans) from the ECB and then buying Italian and Spanish bonds! So the next couple years look pretty good for this interest rate arbitrage that the ECB is encouraging."

Think of it like Deutsche Bank and BBVA doing the same wildly profitable carry trade -- buying higher-yielding assets with cheap financing -- that got MF Global in trouble, without ever having the chance to end up like MF Global! The key, of course, is the guaranteed 1% cost of ECB funds that was not available to the less fortunate and much smaller American futures broker that tried to mimic an investment bank under Jon Corzine's brief leadership.

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European financial stocks are cheap. Based on book value -- a slightly more reliable metric that takes into consideration the banks' earnings power over time -- BBVA trades at 0.86 (discount!) to book while Deutsche Bank trades at even cheaper 0.68 times book. Given the contraction in certain PIIGS' spreads to bunds, it appears that market participants now are willing to differentiate between "good" PIIGS -- Spain, Italy and Ireland -- and the dirty kind like Portugal and Greece. So even a Portuguese default no longer seems as scary at this juncture.

Still, the above are shorter-term tactical considerations for traders trying to make a quick buck. From a longer-term perspective, the problem of the eurozone having one monetary policy and one exchange rate with 17 different finance ministers and 17 different fiscal policies, sometimes in outright friction with the ECB, has not been fixed. A complete fiscal eurozone integration is difficult to imagine, recent statements from eurozone political leaders to the contrary notwithstanding.

Buy-and-hold investors should not overstay their welcome in the current rally in European financials, the length of which will be decided by the direction of the PIIGS' sovereign bond markets. If you are looking for "bombed-out" banks without the macro problems of Europe, consider Argentine financials like BBVA Banco Frances (BFR) and Banco Marco (BMA) that trade at similar book value multiples of 1.22 and 1.17, respectively.

Sure, they have different problems in Argentina, but the actions taken recently by the authorities to reign in inflation are a long-term positive, and the declines of both stocks already reflect many of the risks.

Much has been said about the strong-arm tactics of the Argentine government toward oil giant YPF (YPF) and the directive to cut dividend payments to 57% owner Repsol in order to invest more heavily in oil production (there are plenty of oil deposits in Argentina but not enough investment to extract them). I am not sure this approach will raise oil production in the country. Tax breaks to multinationals and a business-friendly environment, of which the latest governmental actions are anything but, seem like better options.

The above drama has rubbed off negatively on BBVA Banco Frances and Banco Marco, which despite good operational performance in 2011, saw their shares decline and now yield in the high single-digits.

Neither BFR nor BMA are likely to repeat their respective 2011 annual dividends of $1.11 and $2.08 per share in 2012, but given what they have historically paid out on average as dividends, the amount is likely to be high by developed-world standards.

Ivan Martchev is a research consultant with institutional money manager Navellier and Associates. The opinions expressed are his own. This is neither a recommendation to buy nor sell the investments mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell any above mentioned securities.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.
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