Eurozone Recovery Stalls in Q2: 3 Funds to Get Rid of Now - Mutual Fund Commentary

Hopes of economic recovery in Europe received another jolt last week. Eurozone, the 18 nation bloc that comprises some of the behemoths, saw its second quarter GDP growth stagnating. This comes along with a 0.2% contraction in Germany's economy and Italy sliding into recession. The dismal data comes at a time when Europe's banking sector concerns have intensified following the crisis surrounding Portugal's banking giant Banco Espírito Santo.

The zone's manufacturing activity has also been choppy. Evidently, the economic recovery is losing momentum fast. In any case, it is debatable whether a recovery began at all.

Amid this, staying away from certain low-ranked European funds will be a prudent move. We will pick 3 such funds that carry unfavorable Zacks Rank as well. Before we discuss these funds, let's dig deeper into the GDP numbers and Europe's economic woes.

Eurozone Sees Zero Growth; Germany Contracts, Italy Slips into Recession

According to the European Union's Statistics Office, Eurozone economic growth stalled in the second quarter. The zero growth reported by Eurostat was in contrary to expectations of a 0.1% growth. GDP had increased 0.2% in the Eurozone in the first quarter. Eurozone's $13 trillion economy contributes 17% of the global gross domestic product.

The powerhouse Germany saw a surprise dip in its GDP - the first one in over 12 months. Germany's Federal Statistics Office reported a 0.2% contraction in the second quarter. The economic contraction between April and June compared unfavorably to expectations of zero growth. The Statistics Office also revised down first quarter numbers to 0.7% from 0.8%. Nonetheless, the second quarter contraction is a lot to worry about when juxtaposed against first quarter numbers. It was also reported separately that Germany's inflation dropped to the lowest since Feb 2010, at 0.8%.

The surprising Germany contraction was largely an outcome of high level of trade deficit. Declining investments, more so in the construction sector, dragged the GDP to the red.

Eurozone's third-largest economy, Italy slipped into recession after its GDP shrank 0.2% in the second quarter. A Reuters poll had been expecting a 0.2% gain. This was the third instance that Italy slid into recession since 2008. Prime Minister Matteo Renzi now faces severe pressure to implement the structural reforms.

"Growth Broken Down" in France

France, which along with Germany, contributes 66% of the bloc's GDP saw zero growth in the second quarter. France's Finance Minister Michel Sapin said "growth has broken down, in Europe and in France". The nation also chopped its 2014 and 2015 growth forecasts and said it will fail to meet the deficit targets this year.

National statistics office INSEE reported zero growth in the second quarter, mirroring the flat growth also recorded in the first quarter. This makes things difficult for the nation to achieve a 1% growth. French government halved its 2014 growth projection of 1%. The 1.7% forecast for 2015 was also shunned.

As for a trade deficit target, it is unlikely that France would bring the deficit down to 3% by year end, as it had promised to the EU. The sluggish growth and "insufficient inflation" will keep France away from meeting public deficit target in spite of spending control. Sapin said that France will cut its deficit "at an appropriate pace", and revised France's public deficit up to over 4% of GDP this year.

France Blames ECB of Foot-Dragging

Meanwhile, Sapin has blamed the European Central Bank (ECB) for France's failure to meet the deficit target. Speaking to Europe 1 radio, Sapin said: "We must adapt the pace of deficit reduction to the exceptional situation ... of growth that is too weak everywhere in Europe and the exceptional situation of inflation that is too weak across Europe".

Sapin has also urged ECB to be more active to offset deflation threats and to boost growth. Sapin said that the region requires monetary policy "adapted to the exceptional situation of weak growth and weak inflation across the euro zone".

Surviving "External Shocks"

Every quarter of near-zero growth in Eurozone exposes its vulnerabilities. The region has been subjected to a weak banking system, disappointing manufacturing activity and a dismal labor force. In addition, the geopolitical concerns, considered as "external shocks", make the situation murkier.

For instance, the Russia-Ukraine crisis is far from resolved. The ensuing standoff with the greater part of the international community has led to many sanctions. These sanctions affect not just Russia's business, but they do hamper the trade relations a great deal. A recent example is Russia's food import ban in retaliation to the widening of sanctions by the European Union and the U.S.

New sanctions restrict Russia's largest banks from raising finances in European Union and place a trade bar on arms. In response, Russia has banned a wide range of food items, ranging from fruits and vegetables to meat and poultry. This ban will hurt European fruit and vegetables markets heavily. This is because Russia is the biggest importer of European fruits and vegetables. However, the recent figures from Eurostat excludes the period of the deteriorating ties between EU and Russia.

The slowdown in global trade and improved business for emerging markets are an add-on to the plight of European exports.

Portugal's Banking Woes

Last month, Portugal's Espirito Santo International, which is the biggest shareholder in Banco Espirito Santo (BES), halted trading of its shares and bonds as the parent company Espirito Santo International (ESI) allegedly defaulted on a debt payment. It was also accused of accounting discrepancies.

Also, BES, one of the biggest banks in Portugal, had incurred a loss of €3.58 billion in first half of 2014 - the biggest loss in Portuguese banking history. The central bank announced it will split BES into a "good bank" and a "bad bank." The 'good bank' will receive a bailout of €4.9 billion from the bank resolution fund. Out of this, €4.4 billion will be provided by the Portuguese government as a loan and the rest as cash.

The "good bank" will be called Novo Banco. BES' potential assets such as deposits and loans, which can be repaid, will accrue to the "good bank." BES will become the "bad bank." The "problem" assets of the bank will remain with BES. Shareholders and the creditors will be liable for these assets and may lose all of their investments. The Espírito Santo Financial Group, which is one of the owners of BES, and Crédit Agricole (one of the biggest French lenders) are among those which stand to lose.

Meanwhile, The ECB has decided to create a unified watchdog for all Eurozone banks before the end of the year. All the 28 members of the EU will also undergo stress tests to determine how they would respond to another economic slowdown and a slump in the markets. (Read: Stress Tests Ahead: 3 EU Banking Picks )

3 European Funds to Sell Now

Here we will suggest three Zacks Mutual Fund Rank #4 (Sell) or Zacks Mutual Fund Rank #5 (Strong Sell) Europe - Equity funds that should be offloaded from portfolios. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

US Global Investors Emerging Europe (EUROX) seeks capital appreciation over the long term. The fund invests a lion's share of its assets in equities and related securities of companies in emerging markets of East Europe.

The non-diversified fund has returned a negative 10.8% year to date. EUROX currently carries a Zacks Mutual Fund Rank #4 (Sell).

ING Russia A (LETRX) invests primarily in equities of Russian companies. A minimum of 80% of its assets are invested in Russian companies, while the remaining 20% goes into debt securities that are issued either by Russian firms or Russian government.

The non-diversified fund has returned a negative 13.4% year to date. LETRX currently carries a Zacks Mutual Fund Rank #5 (Strong Sell).

Franklin Mutual European C (TEURX) seeks growth of capital. The fund invests most of its assets in those European firms whose market prices are believed to be lower than the intrinsic value. The fund generally invests in companies from five countries, but may also chose to invest its assets in one country. The fund may invest a maximum of 20% of its assets in securities issued by the US, Middle East or other countries.

The non-diversified fund has returned a negative 5% year to date. TEURX currently carries a Zacks Mutual Fund Rank #5 (Strong Sell).

To view the Zacks Rank and past performance of all Europe - Equity funds, investors can click here to see the complete list of Europe - Equity of funds .

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

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

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