The Case for (and Against) European Stocks
Ben Baden

The average European stock fund is up 4 percent so far this year

The dark cloud of the sovereign debt crisis has been hanging over the European stock markets for months. After taking bailouts, Greece and Ireland may be forced to default on their debt or bondholders may have to take a "haircut" and lose some of their principal, experts say. Despite the gloomy outlook for some of these debt-ridden countries, other areas of Europe look promising for investors in 2011.

"I think Europe is a story of two parts," says Dimitre Genov, comanager of the Artio Global Equity fund (symbol BJGQX), which has about a quarter of its assets invested in Europe. Genov says he's avoiding the debt-plagued part of Europe and is instead focusing on countries like Germany, Sweden, and Denmark that have low debt levels and are home to a number of strong, multinational companies. Companies in these countries, such as Siemens and Novo Nordisk, have seen gains as of late. The average European stock fund, which typically has most of its assets in developed Europe, is up 4 percent so far this year, according to Morningstar. That's almost identical to the S&P 500's return so far year-to-date, and much better than the average emerging markets fund, which has shed 5 percent over the same time period.

In 2011, overall GDP growth in the European Union is expected to be relatively low: The developed nations of Europe are expected to grow at a measly rate of 1.5 percent, according to the International Monetary Fund. Compare that with the expected growth rates of the United States (3 percent) and the emerging markets (6.5 percent). But investment opportunities remain. "From a global perspective, it's still a region that's viewed as not super exciting in terms of growth, but the valuation is interesting and there are some great companies that you can find," Genov says.

If investors know where to look, there are plenty of European companies positioned to take advantage of higher growth in emerging markets like China and India. Genov is bullish on automaker Daimler, which is benefiting from the growing demand for cars in these economies. Mercedes-Benz was the fastest-growing premium car brand in China for the third consecutive year in 2009, according to Daimler's most recent annual report. Chad Deakins, manager of the RidgeWorth International Equity fund (SCIIX), is betting on large-cap names like German industrial conglomerate Siemens, which recently won contracts to build two power plants in India, and is working on transmission technology for power grids in Brazil and Paraguay. "It's an overall play on the global economic cycle," he says.

Deakins says European financial services stocks, which took a beating in 2010 over concerns about sovereign debt issues, are a classic value bet, meaning they're relatively cheap and out of favor. Specifically, he likes European insurance companies, including Allianz, along with big banks like Société Générale. Year-to-date, Allianz is up 15 percent, while Société Générale has gained 21 percent. Deakins says he will hold on to them as long as their valuations remain low.

There are also investing opportunities in European emerging markets, which have gone somewhat unnoticed by many investors, says Christian Magoon, CEO of asset management consultant firm Magoon Capital. Some European emerging markets are especially attractive because they have large natural resources deposits, he says. Russia, for example, is the world's largest producer of oil and home to the world's largest natural gas reserves. Emerging economies in Europe also have higher growth projections and fewer debt problems. According to the IMF, the central and eastern European region is expected to grow by 3.6 percent in 2011. For investors looking for exposure to this region, Magoon recommends two exchange-traded funds: iShares MSCI Emerging Markets Eastern European Index (ESR) and SPDR S&P Emerging Europe (GUR). These funds are heavy on Russian stocks, but they also include exposure to other countries like Turkey, Poland, and Hungary.

Going forward, northern Europe's biggest concern is whether growth will slow in robust economies like China, which could hinder earnings growth for some multinational companies, says Martin Jansen, head of international equities at ING Investment Management. To slow inflation, leaders in emerging nations like China, India, and Brazil have raised interest rates, which could crimp growth. Over the weekend, Chinese Premier Wen Jiabao said the country has lowered its growth target to 7 percent, a percentage point lower than it had been over the past five years. (By comparison, the Chinese economy grew at a rate of 10 percent in 2010.)

In peripheral Europe, the economic outlook remains fairly bleak.

In Greece and Ireland, Jansen says, "the probability of a debt haircut ... is pretty significant." As for concerns about the crisis spreading to larger economies like Portugal and Spain, he says they will probably avoid any major debt restructuring.

Unrest in the Middle East is problematic for the entire European region.

Some European countries have close economic ties with politically unstable Middle Eastern nations. Italy, for instance, relies on a pipeline from Libya for a some of its natural gas supply. And there's the more obvious problem. "If [the unrest] spreads further, it could lead to another spike in oil prices," Jansen says. "That, in turn, could really derail a fairly fragile recovery, particularly for the developed countries."

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