If you’ve ever been to a flea market, you know that most things there are cheap for a reason. That $10 Depression glass? It’s not from the Depression, nor is it glass. And that recording you bought of Abraham Lincoln yodeling might be educational, but probably not in the way you think it is.

These days, stocks in Europe — especially Spain and Italy — are cheap indeed. And there’s a reason for that. Both countries are a mess, and their problems reverberate through Europe as a whole. But unlike a 1930 pickle jar, high-quality European stocks could well appreciate over time. If you have the stomach for risk and a love of buying low, European stocks could do well over time.

Whenever you pause to think of how dysfunctional U.S. politics are, consider Italy, where former prime minister Silvio Berlusconi ran against a comedian — which is to say, he ran against someone in his own profession. The comedian, Beppe Grillo, lost, as did Berlusconi. That’s good.

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But the winner, Pier Luigi Bersani, wasn’t able to gain control of Italy’s Senate, which went to Berlusconi. As a result, Bersani will have a hard time getting legislation passed without cobbling together an alliance with Berlusconi and Grillo, who also has a substantial bloc of votes. And there’s no love lost between Bersani and Grillo, who recently called Bersani “dead man talking.”

Then there’s Spain, whose official unemployment level is 25%, and 50% for young men. Its housing bust, as a percentage of gross domestic product, dwarfs ours. The nation is so desperate for foreign buyers that it’s considering offering residency for those who buy homes for more than 160,000 euros.

But it’s the Italian election that has taken the markets aback, primarily because Italy had made solid moves toward addressing its debt problems. And, of course, because Italy is the third-largest economy in the eurozone, and one of six founding members of the European Union. “It was a bad surprise,” says Philippe Brugere-Trelat, vice president and co-portfolio manager at Mutual European Fund.

The eurozone’s ongoing debt problems have been arguably worsened by austerity measures — tax hikes and spending cuts designed to get national ledgers back into balance. While these measures arguably make sense in boom times, they simply make weak economies weaker. It’s like bleeding an anemic patient. “They can’t go on increasing taxes and cutting spending,” says Brugere-Trelat. “That’s not the way to get out.”

In the meantime, European stocks have been lagging behind the U.S. Italy’s market is down 5.1% this year, according to MSCI, vs. a 7.1% gain in its U.S. stock index. Spain has fallen 1.4%, and Germany has squeaked out a 0.4% gain. (The Greek stock market, perversely, has soared 17.4%, which sounds good until you realize that Greek stocks have lost 34.5% a year for the past five years.)

Because of all the uncertainty in Europe, many European stocks are fairly cheap, relative to earnings. Is it time to buy?

Dean Tenerelli, portfolio manager of T. Rowe Price European Stock Fund, is fairly upbeat about Europe, particularly Spain. “They have been through hell,” he says, “but the government has been pretty good with the amount of restructuring they have done.” He has about 12% of the fund in Spanish stocks.

“Companies are not saying they are seeing signs of improvement,” he warns. But he thinks Spanish media companies are a good buy: Advertising is down nearly 80% from its peak, he says, probably as low as it will go. And some of the remaining Spanish banks look cheap as well: Bankinter, which just announced a hike in its capital levels, is one of his favorites.

Brugere-Trelat agrees that Spain may not be as bad as the current economic numbers indicate, noting that the underground economy has helped employment somewhat. “If it [the unemployment rate] were really 25%, there would have been riots a long time ago,” he says.

Europe’s woes allow you to buy stocks of high-quality companies — many with substantial global sales — at relatively low prices, Brugere-Trelat argues. “It all depends on your appetite for risk, and mine is low,” he says. You can find European companies with a global footprint whose sales growth doesn’t depend on European economic growth. Their prices are low simply because they are based in Europe. “You’re not taking the macro risk of betting on whether Italy gets its act together,” he says.

One area that both Brugere-Trelat and Tenerelli like is the European pharmaceutical industry. Sanofi, for example, trades in the U.S. as an American depositary receipt. Current dividend yield: 3.6%. Its price-to-earnings ratio is 6.2. (The PE ratio — price divided by estimated 12 months’ earnings — is an indication of how expensive a stock is, relative to earnings. Lower is cheaper, and 6.2 is pretty darn low.)

Europe could take a long time to pull out of recession, and if you’re investing now, you should realize that you’ll probably take some lumps along the way. Nevertheless, if you believe in buying cheap, Europe is a good place to start looking for real bargains.


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