5 Reasons European Stock Markets Are Beating U.S.

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The headlines out of Europe scream the continent's economic crisis is deepening, unemployment has soared to a new all-time high and that it's just a matter of time before the countries that aren't in a recession join the club. But Europe's stock markets are rallying to new highs, suggesting they're climbing the proverbial "wall of worry" typical of bull markets.

IShares MSCI EAFE Index ( EFA ), the flagship ETF tracking foreign developed markets, climbed a decent 5.81% in the past month and hit a 52-week peak Tuesday. It's ahead 14.5% for the year.

Vanguard MSCI Europe ETF ( VGK ), the largest ETF focused on the continent, climbed 6.78% the past month and 19.00% year to date. TheSPDR S&P 500 ETF ( SPY ) gained 3.79% and 16.06% over the same periods.

Here's a look at five catalysts boosting European stock markets.

1. They're reverting to the mean .

A part of Europe's outperformance this year could be what Wall Street calls the "reversion-to-the-mean" theory, in which a market that lags one year outperforms the next and vice versa. VGK sank 11.64% in 2011, while the SPY added 1.89%.

But it also has much further to go before regaining its prefinancial crisis high than SPY. VGK has to gain 12% to regain its 2011 peak and 63% for its 2007 top. By contrast, SPY only has to gain 10% to recover its 2007 high.

2. Sweeping central bank action boosted financials.

The European Central Bank's aggressive economic stimulus along with central banks across Europe significantly reduced bond yields and borrowing costs, benefiting financials, noted Ivka Kalus-Bystricky, portfolio manager of Pax World International with $44 million in assets. Financials, VGK's biggest sector, account for nearly a fifth of the Pax fund's assets.

Also, the euro, which slumped against the dollar in the first half of the year, is now about where it started the year.

3. They're a contrarian bet.

Analysts agree the eurozone will see no growth next year and are much more bearish on Europe than the U.S., and the market tends to go against the crowd, Kalus-Bystricky added.

4. The eurozone stayed intact.

European stock markets sold off hard in the second quarter on fears of the eurozone collapsing and those fears diminished when European leaders pledged to "do whatever it takes" to keep it together.

"This development appears to have outweighed the economic slowdown, which was already widely anticipated and probably pretty much priced in," said Bill Witherell, chief global economist at Sarasota, Fla.-based Cumberland Advisors with $2.2 billion in assets under management. "Also expectations for the global economy and hence Europe's markets have improved recently with clear indications that the slowdown in China has ended."

But he says he's "leery" of all European markets except for Germany, France and the Netherlands.

5. They're a bargain compared with U.S. stocks .

VGK trades at a discount on all valuation metrics compared with SPY while offering a slightly higher dividend yield. VGK's stock trades at 11.6 times forward earnings, 1.3 times book value; 0.85 times sales; and 3.31 times cash flow. It has a dividend yield of 3.43%.

SPY sports a price-to-forward earnings ratio of 14, price-to-book 2, price-to-sales 1.29, price-to-cash flow 7 and a dividend yield of 2.28%.

Downside Risks

If Congress and the president reach a deal on the fiscal cliff, European markets could rally through the first quarter of next year before correcting again, says Wojtek Zarzycki, chief investment officer at Optimal Investing, based in Toronto and New York, with $150 million in assets under management.

But should the U.S. go over the fiscal cliff, the global markets will likely repeat the movie from Sept. 29, 2008, when the House rejected the controversial $700 billion financial bailout plan, known as TARP. The Dow plunged 7% that day and 30% over two weeks. It took a year and a half to regain its losses.

Top 10 Europe ETFs

Here's an overview of 10 European country and regional ETFs, listed in alphabetical order, that are breaking out to new highs.

Looking at ETFs making new highs increases the chances of finding winners. As with individual stocks, the ability to clear points of previous resistance is a sign that buyers significantly outnumber sellers.

These ETFs also have IBD Relative Strength Ratings of 75 or higher and Accumulation-Distribution Rating of C or higher. That means these are rising faster than at least 75% of the market and institutions are buying more shares than selling.

1.iShares MSCI Austria Investable Market Index ( EWO ).

2.iShares MSCI Belgium Capped Investable Market  ( EWK ).

3.iShares FTSE EPRA/NAREIT Developed Europe Index  (IFEU).

4.iShares MSCI France Index (EWQ).

5.iShares MSCI Germany Index (EWG).

6.iShares MSCI Netherlands Investable Market Index (EWN).

7.Global X FTSE Nordic Region ETF (GXF).

8.iShares MSCI Poland Investable Market Index (EPOL).

9.iShares MSCI Sweden Index (EWD).

10.iShares MSCI Switzerland Index (EWL).



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: EFA , EWK , EWO , SPY , VGK

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