Walk around virtually any city in Europe, and you'll get a
glimpse of deep economic strains.
Many store fronts are boarding up, people are walking the
streets with hopes of finding employment andlandlords are evicting
tenants who are far behind in rent.
Yet, economists increasingly expect the gloom to
lift slowly. And if history is any guide, then you want to
invest in troubled Europe before the region'seconomy is back in
This notion hasn't been lost on some investors who are already
profiting from increased exposure to Europe. But these investors
were mostly focused on the riskieststocks that appeared to be the
most distressed. Many Italian bank stocks, for example, have risen
50% or even 100% since bottoming out last summer.
But for investors looking to commit freshfunds to
Europeaninvestments , it may be wiser to take a different
Focus on stocks and funds that remain near lows, but have a high
degree of economic sensitivity. Once investors have become
convinced that Europewill indeed exit arecession in comingquarters
, then it's the
deeply-cyclical (often industrial) stocks
that will likely greatly benefit.
Here are three examples...
This Luxembourg-based steel maker derives more than half
of its sales from Europe. The deep recession has dealt a
double-barreled blow to the company as European auto sales
plunge to new depths and commercial building construction
grinds to a halt. These two industries are huge consumers
From a peak of $117 billion in sales in 2008, sales are
expected to come in at just $84 billion in 2012. Analysts
expect only modest improvements, perhaps to $86.5 billion
in sales in 2013. Yet, the tepid top line masks a vastly
streamlined cost structure that should start tobear fruit
ArcelorMittal generated a $3 billionfree cash flow loss
in 2011, and likely a small free cash flow loss in 2012 as
well. But analysts at Merrill Lynch say that recent cost
cuts and constrained capital spending should enable free
cash flow to rebound to $2 billion this year, and perhaps
$4 billion in 2014. By the time the European economy is
back on its feet in subsequent years, free cash flow could
really take off. After all, the company averaged $7.8
billion in annual free cash flow in 2007 and 2008, the last
time the cycle was at its peak.
The European auto industry is in brutal shape. Only the
German manufacturers have been able to sideswipe the deep
sales plunge, thanks to a focus on the high end of the
domesticmarket and exports to the United States. As
operating losses mount, European automakers are finally
taking action, shutting down excess capacity and rewriting
labor agreements. It's a slow process that has only begun
to play out, but the industry should emerge from this
brutal period in stronger shape.
Perhaps more important, Europe may soon start to see a
snapback in car sales. As was the case in the United States
when consumers began to replace aging vehicles while our
economic downturn receded from view, so will European
Fiat may be especially well-positioned. Not only could
the Italian car market rumble back to life, but Fiat is now
generating impressive returns from itsinvestment in
Chrysler. How important was that purchase? The roughly $30
billion in sales that Chrysler brought to Fiat replaced a
similar-sized hole created by the plunging Italian market
for Fiat. In other words, Fiat's reported $83 billion in
2011 sales would have been closer to $53 billion, or a 40%
plunge from the 2007 peak.
Analysts expect Fiat's sales to rise to $109 billion in
2012 and to about $115 billion this year. Profits are
returning as well. After bottoming out at 28 cents a share
in 2012, consensus forecastscall forearnings per share of
about 75 cents this year.
Yet here again, the long view is warranted. As the
European economy finally starts to grow again in coming
years, Italian consumers will need to replace their aging
vehicles. By the time that happens, thisstock won't be
anywhere close to current levels.
A pair of
Though it's hard to find investors who squarely focus
upon European industrial firms, a pair of these types of
funds give more general exposure to the region.
The PowerShares FTSE RAFI Developed Markets
First Trust Developed Markets Ex-US AlphaDEX ETF
could likely generate strong returns if the European
economies can sustain an upturn in coming years.
Risks to Consider:
There is always the chance that Europe's economies stumble
anew. This would be especially bad news for heavily-indebted
companies such as ArcelorMittal and Fiat.
Action to Take -->
It's time to start positioning your portfolio for this
impending bounce. Europe's possible exit from recession later this
year is likely to be met with little fanfare. Companies and
consumers alike will still be in a foul mood. But as we've seen
with U.S. stocks, investments in troubled areas can start to rally
long before the champagne corks have been popped.
-- David Sterman
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David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of MT in one or more of its "real money" portfolios.
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