Europe, which has been long believed to be simply too volatile for prudent long-term investors, appears to have turned the corner.
The world experienced years of one crisis after another sweeping the eurozone. These financial missteps destabilized the equity markets, creating a dangerous place for investors. Last year, European Central Bank President Mario Draghi made the unprecedented promise that he will "do whatever it takes" to save the common currency. This single statement has led to greater stability to the European Union's (EU) economy and growth in the stock market.
Certainly, not all regions are thriving, but things are improving enough to create a compelling case for diversification into the European stock markets.
The primary reason for this improvement is the full-force support of the EU Central Bank for the unified euro currency. Fears of the euro being devalued or even eliminated resulted in deep economic stability concerns due to lack of trust in the currency. Now, these fears have lifted, bringing back the confidence needed for stock market growth.
Signs of greater confidence in the EU economy include the first signs of growth for the past six quarters. In the second quarter, the eurozone economy beat estimates by expanding 0.3%. Clearly, this isn't much, but it's the first green sprouts after the long economic winter.
As an investor, what I like best is the fact that euro stocks trade at a 25% discount to long-term valuation. Overall, euro stocks are at a 50% discount to the book value of U.S. stocks. The European economic crisis has created opportunities for savvy investors.
How To Profit
The smartest way investors can profit from Europe's upward economic momentum is through exchange-traded funds (ETFs), which provide targeted exposure combined with professionally managed diversification within the particular niche. They make much more sense than an investor attempting to purchase individual companies within the region to capture profits.
My favorite ETF to ride Europe back to prosperity is the Vanguard FTSE Europe ETF (VGK). As its name implies, this ETF is intended to mirror the performance of the FTSE Developed Europe Index. Launched in 2005, the fund represents companies in 15 EU countries and is well capitalized with an asset foundation of just under $6 billion. It also boasts substantial liquidity with about 2 million shares traded.
The fund holds 503 stocks, with slightly more than 19% of the portfolio held in the top 10 holdings. No individual holding exceeds 3%, with Nestle the largest individual holding at 2.9%. Royal Dutch Shell and HSBC Holdings take the second- and third-heaviest weighted allocations.
VGK's Top 10 Holdings
Financial services is the largest single sector with consumer defensive and industrials filling the second- and third-biggest sectors.
VGK's Sector Weightings
There has recently been a significant increase in capital flowing to this fund in the seven days prior to Aug. 20. According to research firm ETF Channel, there was a $621 million inflow, a week-over-week increase of just over 8%.
Over the past year, the fund has returned 12.5% with a yield a little less than 5.5%.
A look at the technical picture shows VGK has been in a sharp uptrend since June 24. The fund has climbed more than 12% to the $53 area in the past two months. Technical support exists at $52, creating a strong risk-to-reward ratio for a long-term entry.
Risks to Consider: The eurozone is improving, but it still has a long way to go. Southern regions such as Italy and Spain may continue to struggle while they gain footing. I'm not suggesting that investors go all-in on the pending EU recovery, as the risk remains high despite the positive signs. However, it is time to start diversifying into Europe to capture the substantial upside potential.
Action to Take --> Entering the VGK ETF at the current level in the $53 area with stops just below support at $52 makes solid technical sense. My six-month target for shares is $60.
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