European Revival? Maybe

February 12th, 2015
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Investing Daily Article of the Week

by Bob Frick

Almost exactly 200 years ago, the Duke of Wellington almost lost the day to Napoleon at Waterloo. But on June 18, 1815, the Prussians showed up in the nick of time, and cut short Napoleon's comeback. Talk about a close call - even Wellington said the battle was "the nearest-run thing you ever saw."

Follow up:

Just as Europe couldn't seem to shake Napoleon at the start of the 19th Century, Europe's economy can't shake recession since the Global Financial Crisis struck eight years ago. The European Union's GDP plunged to -4% in 2009, struggled up to +2 in 2010 and 2011, and since then been flat-lined.

So weak is the EU, and so low are inflation and interest rates there, that many analysts fear the EU is on the brink of a deflationary spiral. This is a condition where prices drop, people and firms wait to buy because prices are falling, which causes prices to drop further and firms to cut back on spending and employment ... the end result can be a depression.

But history may show that 2015 is the year the EU declares victory over its economic quagmire. Given the possibility it could have been sucked into a deflationary vortex, an EU recovery may be seen as the nearest-run thing you ever saw, economically speaking.

I finally have faith that a real EU recovery could be coming from both the big picture and many small pictures. At the individual-firm level, Banco Santander, the Spain-based multi-national bank, this week reported a 70% jump in 2014's fourth quarter profits versus the same period in 2013. (It's a member of our Global Income Edge Aggressive Portfolio.)

One bank reporting big profits wouldn't be a big deal, except this banco is the biggest in the Eurozone by market value. Further, its European operations are leading the charge, with profits in Spain nearly tripling, and the United Kingdom replacing Brazil as its most profitable market. Spain has been one of the more troubled EU economies.

And the big picture also became much brighter this week. EU officials revised their economic forecast for the region, and for the first time in eight years they predicted growth in all the EU's 28 countries. Growth isn't going to be blockbuster, but at a forecasted 1.7% for this year, up from 1.5% predicted in November, the trend is at least in the right direction.

Playing the role of Gebhard von Blücher (the Prussian field marshal at Waterloo) is a trifecta of factors that may rescue the EU. First, the weak euro will boost exports, as EU goods become cheaper relative to goods from countries with strong currencies (such as the U.S.). Second, depressed oil prices will help Europe relative to other zones that produce much more oil (such as the U.S.). And third, the European Central Bank is mimicking other countries' (such as the U.S.) monetary policies designed to jump-start lending and commerce.

So what does it mean to your investments? Hopefully you already have some European exposure, as it should be part of a balanced portfolio. After all, the EU accounts for about 19% of the world's economic output, roughly equivalent to the U.S., and it has a good long-term record of performance. As measured by the iShares Europe ETF (IEV), the Eurozone has returned 9.4% on an average, annualized basis for the last three years, and 8% for the last five.

It's also our chief trading partner, which means our strong dollar and our stronger recovery will help pull the EU out of the doldrums.

I don't believe in market timing, but I would say now is a good time to add European stocks if you don't already have some. I invest in Europe through mutual funds. One you might consider is a member of our Personal Finance funds portfolio: Causeway International Value (CIVVX). It currently has about 72% invested in Greater Europe, and has returned 10.6% for the last three years and 9.4% for the last five, on an average annualized basis.

Europe is not out of the woods. But just as Napoleon knew he was pretty much cooked whether he won at Waterloo or not, a real European recovery is inevitable, sooner or later.

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