Friday, 14 September 2012

Europe - Is Now a Good Time to Invest?

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful" - famous investor Warren Buffett, quoted on Wikiquote

Fear seems to have reigned in Europe ever since the credit crisis and market crash of 2008. Every year and month a new crisis seems to have arisen - governments about to default on debt, or seemingly headed that way; banks in need of recapitalization; property values in the dumpster; potential eurozone breakup; ongoing economic recession and high unemployment.

It's no surprise that European stocks have been hammered and are still way down from the pre-crisis 2008 peak. An easy way to see this is through broad multi-country European equity ETFs. ETFdb's Head-to-head comparison tool tells us that the 5-year performance of the biggest broad-based (455 holdings in 16 countries) European ETF Vanguard's MSCI Europe ETF (NYSE: VGK) is a painful minus 19.3% while the USA's benchmark ETF, the SPDR S&P 500 (NYSE: SPY), is a positive 7.97%.

Enticing Fundamental Indicators - Price/Earnings, Price/Book, Dividends
Will things start to get better in Europe? If that is so, the numbers in our comparison table below look quite attractive in terms of three common measures of stock valuation. P/E and P/B are both appreciably lower, and dividend yield appreciably higher, than for the benchmark ETFs in both the USA  and Canada (iShares S&P/TSX 60 Index ETF symbol TSX: XIU)

The dividend yields in particular offer promise beyond the mere fact that more money is being dished out to the investor. As we have written about before in Are Stocks Risky in the Long Run? and in What Long Term Return Can We Expect from the TSX? high dividend yields have often foretold higher returns. The following chart from shows that dividend yields in Europe, as shown by the iShares S&P Europe 350 Index Fund (NYSE: IEV; blue line in the chart image), are higher now than they have been through the past decade, except for the huge spike at the height of the financial crisis. In contrast, the USA's SPY (the yellow line) is trundling along quite close to its pace of ten years ago.
IEV's distributions did fall sharply after 2008 but they have steadied and even recovered some since. VGK shows a similar pattern when the IEV vs VGK comparison is made in ETFReplay.

Not much banks or PIGS countries in European ETFs
A reassuring fact is that the holdings of the big European equity ETFs are not heavily concentrated in either financial services or in troubled PIGS countries (Portugal, Ireland, Greece, Spain). Financial services stocks make up only 17-19% of either IEV or VGK and only one bank - HSBC - is in their top ten holdings. Spain is the single largest troubled country at 4 to 5%. The UK, France, Switzerland and Germany make up the bulk of the holdings. A glance at the individuals companies in the ETF's portfolios reveals many large multi-nationals like Shell, BP, Novartis, Vodafone, whose fortunes rely on many countries, not just Europe.

Negative outlooks remain, however has piggybacked its stock grading tools to do assessments of some ETFs (not all are covered, and unfortunately, not IEV or VGK the two European equity leading ETFs) based on the stocks inside. MarketGrader's rating, as seen in the screenshot below, of the Powershares BLDRS Europe 100 ADR Index Fund ETF (NYSE: ADRU) is negative - two thirds of its component stocks it rates as "sell" and so therefore the whole fund is rated a "sell".

At the same time, the majority of companies suffer from neutral or negative sentiment, which is MarketGrader's assessment of overall supply and demand for each stock based on such factors as the way whole sectors are loved or hated by the markets at the moment. However, market fear marks the potential opportunity according to Buffett. Are market doubts and fear subsiding or is bad news to continue for years more in Europe?

Which ETF to invest in Europe?
Of the ETFs in our comparison table, Vanguard's VGK offering has the advantage of the lowest MER (we note Buffett's words on the importance of costs) and the broadest diversification / most stock holdings. Its P/E, P/B and dividend yield are bottom or close to bottom among this lot of ETFs as well.

There are of course other ETFs with even broader geographic range in which Europe is a significant part, such as EAFE / developed country funds, or even all-world funds. But then the impact of a resurgence in Europe gets diluted. Going the other way, there are individual country funds e.g. iShares Spain (NYSE: EWP) or Germany (EWG), which allows picking which countries to include or exclude. There the downside is complication of the portfolio - more holdings are harder to re-balance to maintain an asset allocation. Also, such ETFs generally sport higher MERs.

Whether to go ahead and invest requires consideration too of the other element in the Buffett quote - are we getting unduly excited or is this a cold-blooded opportunity? Will the recent actions by the European Central Bank and the US Federal Reserve that have boosted markets in Europe, along with the rest of the world, have long-lived effect this time? We believe more in the existence of a real opportunity in Europe right now but only time will tell.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

1 comment:

CanadianInvestor said...

Thanks for the kind words, OFT