AN AGREEMENT between European leaders to help save the
eurozone fails to address one main problem: Europe's economies are growing too
slowly.
The deal, announced on Friday, attempts to prevent another
fiscal crisis by imposing strict budget guidelines for nearly every member of
the European Union. The United Kingdom was the lone holdout.
The agreement "is about a vision of what Europe will
look like in the next 100 years, but markets are worried about the next 10
days", said Nicholas Colas, chief market strategist at ConvergEx Group, a
New York-based financial technology firm.
With slow growth, high debt burdens and cost-cutting
austerity measures that could further weaken spending in countries like Italy
and Greece, a Europe-wide recession looks more likely, analysts say.
Standard & Poor's expects that a recession that began in
Spain, Portugal and Greece over the last year will spill over into larger
economies like France and Germany in the first six months of 2012. GE Capital's
CFO Jeffrey Bornstein said last week the company expects a recession in Europe.
Here are three considerations for investors on how to play a
looming EU recession:
In Europe, but not of it
Exports have been a key reason the German economy has held
up better than its European peers. But the German government said on Friday
that exports fell 3.6% in October from the month before. Declines in Europe,
which collectively makes up more than half of all German orders, are partly to
blame.
Select German exporters remain good bets based on current
valuations and also on expectations that exports to the US and China may
outweigh any current weakness, some investors said.
"Speculators have been using German stocks as a proxy
for their (European-wide) market viewpoints" ignoring individual stock
fundamentals, which has made some valuations attractive, said Geoffrey
Pazzanese, manager of the $550m Federated InterContinental Fund (RIMAX).
The German market is trading at nine times forward earnings,
compared with a 12 times forward multiple for the S&P 500.
Pazzanese is buying shares of Daimler because of its
strength exporting automobiles to the US and China. He expects the US auto
sector to be strong in 2012 because consumers have largely delayed replacing
their vehicles since the US recession. He expects more than 20 million vehicles
to be sold in China, making it a larger market than the US.
Daimler trades at a price to earnings multiple of seven,
well below its 52-week high of 19, and offers a yield of 5.4%. Siemens is
another global company that, with a yield of 4%, offers a high dividend.
"These companies are not value traps, and Germany is
not a value trap," Pazzanese said.
Another undervalued option is exchange-traded fund (ETF) the
iShares Germany ETF (EWG), which is down 16% this year, holds Germany's largest
50 companies and yields 3.3%. Siemens makes up 10% of the fund's assets;
Daimler accounts for 5%.
The United Kingdom is another option for investors. It is
part of the European Union but does not share the euro. This gives the UK an
ability to control its currency rates through measures like quantitative
easing, something barred by the European Central Bank.
Quincy Krosby, market strategist at Prudential, said she
expects the UK's FTSE index to outperform other European countries over the
next year. "We're in an environment where global growth is slowing, and
countries in which central banks can control their currency will see their
markets do better," she said.
One broad investment option: HSBC's FTSE 100 ETF (UKX), down
3.7% this year, tracks the largest 100 UK companies. Its top holdings are
multinationals like BP, GlaxoSmith Kline, and British American Tobacco.
Be mindful of European exposure
US investors' domestic holdings are not immune to the impact
of a European recession. Sales in Europe make up about 20% of revenues for
companies in the S&P 500 index.
Some companies derive even more revenue from Europe. A full
56% of sales at Cisco Systems come from Europe, according to Thomson Reuters
Datastream. McDonald's gets 42% of its sales from Europe; for Kraft Foods it's
32%.
"You can't imagine that (these companies) aren't going
to face headwinds in terms of Europe," said Bill Stone, chief market
strategist at PNC Financial. That makes it prudent to sell such stocks before
any further decline in Europe.
Cisco, in particular, may have further to fall. Its shares
are among the five most-shorted on the Nasdaq, a likely drag on stock
performance. The company is down 6% this year, compared with a 4% gain for the
Nasdaq index.
Industrial and technology companies, which are the most like
to export goods to Europe, may also be expensive. "The valuation gap has
narrowed, making (these sectors) less attractive," Jonathan Golub, chief
strategist at UBS, wrote in a note to clients.
Euro falling
Analysts say the euro will likely continue to fall as the
debt crisis continues, leaving open currency plays.
Pazzanese, the international fund manager for Federated, has
seen a negative effect of the weakening euro on his returns. "We're dollar
denominated investors," he said.
"While we might have a good stock idea, our returns on
the trade will be in euros and we then translate that into dollars", a
process that sometimes makes him lose on the exchange rate. He protects his
stock investments by simultaneously shorting the euro.
The PowerShares DB US Dollar Index Bullish (UUP), an ETF
that tracks the performance of the dollar against the euro and five other
currencies, is one option for cover.
"This fund could provide a useful hedge to US investors
with substantial holdings in European equities" by balancing out the
currency risks, noted Michael Rawson, an ETF analyst at Morningstar.