June 16, 2024

Fundamentally: The Case for Europe’s Blue Chips

Even as European leaders grapple for a solution to their region’s debt crisis, Wall Street is now debating another question: Should investors, who are flocking to blue-chip stocks for the first time in years, favor the European or domestic variety?

Both the Morgan Stanley Capital International Europe index and the Standard Poor’s 500 are up nearly 4 percent this year. “European stocks still offer compelling values,” said Mark D. Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia.

The price-to-earnings ratio for European shares is just 13.2, below the 15.2 of the S. P. 500. For many years previously, European stocks traded at a premium to American shares.

There’s also the currency advantage to consider. The Wall Street consensus is that the dollar is likely to weaken further against the euro this year, continuing a trend that’s been unfolding since last summer. If that happens, Americans who invest in European shares will enjoy a lift — over and above any stock price gains — just because of the euro’s relatively stronger value.

They’re already enjoying that tail wind. Shares of Siemens, the German conglomerate, for example, have gained 2 percent this year, as the company has enjoyed better-than-expected profits — partly because of sales growth in rapidly expanding emerging markets. But tack on the effect of the weakening dollar and those returns more than double, to 5 percent.

“A weak dollar is good if you’re an American investing overseas,” said Alec Young, international equity strategist at S. P. Equity Research Services. But “if it lasts too long,” he added, “it could turn out to be bad.”

Just as a falling dollar can improve prospects for American investors abroad, it can be a boost for domestic companies trying to export their products overseas. That’s because a weakening currency makes their products cheaper for foreign customers. Conversely, a stronger euro makes it harder for European companies to export their goods.

“There is a price at which the currency exchange rate impacts the business model,” said David R. Kotok, chief investment officer at Cumberland Advisors. “It’s north of $1.40,” he said, referring to the current exchange rate of just under $1.40 to the euro. “But is it $1.50, $1.60, $1.70? I have no idea.”

For now, he said, European stocks still look attractive.

But it’s not just the weakening dollar that investors must weigh, some strategists say. Another consideration is why the dollar is falling against the euro in the first place.

One reason is that the European Central Bank has signaled that it may soon raise short-term interest rates to combat a rising threat of inflation. In fact, Jean-Claude Trichet, the central bank president, recently hinted that a rate increase could come as early as next month. By comparison, most investors think the Federal Reserve will hold short-term rates in the United States steady until the start of 2012.

Why are the European bankers considering such a quick move? Consumer prices in the region have risen 2.3 percent over the last year, noticeably faster than the 1.6 percent gain in the United States. And rising oil prices, spurred by the political turmoil in the Middle East, is likely to feed European inflation fears.

If the European Central Bank does tighten its monetary policy, it will not only be tapping the brakes on the region’s economy, but may also put further pressure on the dollar, because global investors will be rewarded with higher yields for parking their cash in euros. That, in turn, may add to the pressure European exporters — and their earnings.

“With slower growth and slightly higher inflation there, I would imagine the profit squeeze in Europe will be a little bigger than in the U.S.,” said Nariman Behravesh, chief economist at IHS Global Insight.

Would that be enough to snuff out the European rally?

Mr. Young said he didn’t think so. “If we were talking about rates moving from 4 percent to 5 percent, this would be a bigger issue,” he said. But since rates are only about 1 percent now, “It’s not that big a factor,” he said.

James W. Paulsen, chief investment strategist at Wells Capital Management, disagrees. He said that if the European Central Bank soon raised rates, “European policy officials will probably come to realize by late summer that they tightened too early.”

He expects the domestic economy, meanwhile, to keep heating up. “The combination of hotter growth here and policy changes that could slow the growth there would seem to favor domestic large caps,” he said.

For the moment, investors who are wondering where to place bets may want to make decisions case by case and sector by sector, Mr. Kotok said.

Because of uncertainties about health care reform in the United States, he said, investors looking at pharmaceutical companies might favor Sanofi-Aventis — the French giant that recently bought Genzyme — over a domestic drug maker.

But, he said, if investors want to bet on energy, they might favor a domestic player like ExxonMobil over Royal Dutch Shell, based in the Netherlands, as Exxon is making a big push into the potentially promising domestic natural gas market.

When it comes to your overall portfolio, though, it’s ultimately not a case of either/or, he said. “You need to own stocks both here and over there to be properly diversified,” he advised.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

Article source: http://feeds.nytimes.com/click.phdo?i=d34ec8dedea5e0e05f3c18a86e6962b9

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