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Trading World Tour: Will Europe Take The Torch From U.S.?

Trading World Tour: Will Europe Take The Torch From U.S.?

As U.S. stock averages clawed and scraped to fresh record highs in the first half of 2015, it was easy to forget that European stock markets roundly beat their U.S. counterparts. Now the question becomes: Will Europe take the torch from the U.S. in the second half?

Through early June, the Dow Jones Industrial Average (DJIA) gained 1.42% on its way to record territory. But the multi-country Stoxx Europe 600 Index soared a whopping 15.6%. There were several factors behind its move, including monetary stimulus by the European Central Bank (ECB), a weaker euro's benefit to European exports, and cheaper oil prices.

Economic "Juice"

Europe's own quantitative easing (QE) plan has been "juice" for its markets because it feeds a hungry economy and fights the threat of deflation with plenty of nutrients. Some traders may remember ECB chief Mario Draghi's now-famous comments that the central bank will do "whatever it takes" to tackle low inflation. In January, the ECB expanded its asset purchase program to €60 billion per month. And it stuck, giving a boost to eurozone growth forecasts.

"After growing 0.9% in 2014, we expect real GDP [in the eurozone] to grow 1.5% in 2015 and 1.8% in 2016," said Andrew Labelle, economist at TD Economics.

Just as the U.S. Federal Reserve's massive monetary stimulus has helped underpin the rising trend in U.S. stocks, now Europe may be seeing a similar scenario unfold.

"The ECB has gone down the same path as the Federal Reserve, and it has been viewed as especially supportive for European bourses based on how the U.S. market traded after the implementation of QE in the U.S.," said Patrick O'Hare, chief market analyst at

The same might be said for the ECB's QE program. "Long-term bond yields are very low from a historical standpoint," Labelle said. "This, along with renewed confidence in the banking sector—partially as a result of the ECB's stress tests—has led to a pickup in credit growth."

The Strength in a Weaker Euro

"The main by-product of the ECB policy has been a significant depreciation of the euro, which is strongly helping all eurozone economies," said Jose Garcia-Zarate, senior analyst at Morningstar Europe. That's a big boon to European exports, as it ups the value of company earnings abroad and provides a boost to competitiveness.

Related Link: Mid-Year Stock Playbook: Greece, China, Fed...What's Next?

Indeed, the value of the euro against the U.S. dollar has fallen significantly over the last year, from around $1.40 in May 2014, flirting with parity, and then rebounding slightly to around $1.12 in late June 2015 (see figure 1).

Looking ahead, "there is an expectation that earnings growth should be picking up—an idea that has also been bolstered by the weakening euro, which is a benefit for eurozone companies that sell overseas," said O'Hare. amtd_7-9_2.png FIGURE 1: CLOSE TO PARITY. A five-year view of the euro against the U.S. dollar. The cross neared parity early in 2015 before a rebound; it moved lower again in late June when Greece neared a major debt payment deadline and was scrambling to renegotiate with creditors. Chart source: TD Ameritrade's thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Cheaper Oil

At least in theory, a drop in crude oil prices is like a pay increase for consumers. It's presumed they typically use gas-pump savings to shop for other goods and services.

From a peak above $110 per barrel, West Texas Intermediate (WTI) crude oil futures prices dropped to a low around $42 per barrel in March before rebounding toward $60 in early June. And Europe-based Brent traded just above $64 a barrel in early June, up from sub-$50 a barrel in March but well off its peak at $145 a barrel in 2008.

"We are enjoying much cheaper energy prices," Morningstar's Garcia-Zarate said. "It incentivizes consumer spending and corporate investment, which explains why markets are looking at European equities much more favorably."

Strong Chain With Weak Links

It's always important to remember that because the eurozone is not just one country but many, the chain has stronger and weaker links.

Many analysts point to Germany as the economic powerhouse in the region. Germany boasts a strong reputation for budgetary conservatism and is the de facto political head of the eurozone.

TD Economics forecasts real GDP growth for Germany in 2015 at 1.6%. "The unemployment rate is at a record low and wage growth is robust, which is supportive of domestic demand. Meanwhile, its external sector remains extremely competitive," Labelle said.

"Germany has a very disciplined approach to budgets," said John Krey, international investments analyst for S&P Capital IQ. "They don't engage in reckless spending, and they try to keep revenue and spending in balance." Krey called Germany's broad DAX stock index one of the "cheaper markets in Europe" right now. "In my view it is a very good buy," he added. The one-year forward price/earnings ratio on the DAX stands at 14.2.

Given the ongoing economic and debt angst in Greece, it's probably no surprise that many industry analysts consider it the weakest link—so weak that valuation isn't yet part of the equation, and perhaps understandably it's a country some investors may choose to avoid. "Greece has a whole lot of problems—political, economic, and otherwise—that make it a speculative bet at best," O'Hare warned. "The possibility of outsized gains exists, but so does the possibility of outsized losses. Investing in Greece at this juncture isn't for those with weak stomachs."

The debt crisis may not be exclusive to Greece, of course. As of publishing, Portugal—about three years clear of a bailout agreement—was back in the headlines. According to the latest figures from Eurostat, the European Union's statistical agency, Portugal's debt-to-GDP ratio has climbed to 130%. Of that, 70% is owned by foreigners who could come calling.

Paint Europe In Broad Strokes

"Investors, particularly retail, tend to have a home bias because it is what they naturally understand," Morningstar's Garcia-Zarate said. "However, by not branching out they miss out on potentially very interesting opportunities.

"Europe is a case in hand," he said. "Adding some exposure to international markets can be a good idea, as long as one is cognizant of the potential risks."

Unless you're a seasoned pro with deep knowledge of the eurozone, take a big-picture look. "Don't bother picking individual European countries unless you're absolutely sure you know all the ins and outs," Garcia-Zarate said. "Dip your toes in the European market via a broad-, rather than single-country, exposure."

Investors might explore opportunities in Europe through exchange-traded funds (ETFs). Some ETFs focus on Europe overall, while others zero in on individual country stocks. Diversification within an investment portfolio always makes sense, irrespective of the type and geographical location of the investor, Morningstar's Garcia-Zarate said.

Committed, With Risks

For now, countries within the eurozone appear committed to maintaining the stability and credibility of the union. However, that doesn't mean there aren't risks in an area marked by unique countries, economies, and cultures.

"A Greece-triggered breakup appears unlikely, at least in the short- and medium-term," Labelle said. "There is a clear consensus among countries to maintain the euro. There have also been significant reforms and initiatives undertaken, such as the creation of the European Stability Mechanism, which can help rescue smaller countries if difficulties arise."

However, Labelle warned of bigger risks should a larger euro-area country, such as Italy, hit a difficult financial wall. "The rise of euro-skeptic parties also poses some risk from a political standpoint," he said. (Euro-skeptic parties are anti-establishment parties that mostly want to abandon the eurozone and, for many, the euro.)

Changing Of The Guard

So is the U.S. equity market bull, now in its sixth year of gains, handing the bull market torch to Europe? Garcia-Zarate, for one—and keep in mind that this is his opinion—sees the start of Europe's bull cycle now that the market is "starting to grow on solid fundamentals.

"In simple terms, market participants now see more scope for growth in Europe simply because the U.S. has already had it," he said. "This doesn't mean the U.S. equity market is a bad proposition. It simply means there may be more opportunities in Europe."

"And," he added, "money flows where there is scope for opportunities." That's how he calls it, of course, every investor has to decide for themselves. This piece was originally posted here by Kira Brecht on July 7, 2015.

TD Ameritrade, Inc., member FINRA/SIPC. Commentary provided for educational purposes only. Past performance of a security, strategy, or index is no guarantee of future results or investment success. Inclusion of specific security names in this commentary does not constitute a recommendation from TD Ameritrade to buy, sell, or hold.

Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before investing. Supporting documentation for any claims, comparison, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

Posted-In: Kira Brecht The Ticker TapeEducation Opinion Economics Markets General Best of Benzinga


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