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).