Green Shoots in Europe?

Tom Essaye

The market’s attention is currently focused on the fiscal cliff. Meanwhile, the area of concern for most of the year, Europe, has quietly seen some positive signals. And as Washington bickers, things in Europe continue to heal and improve.

Starting with the ECB’s announcement of the Outright Monetary Transactions (OMT) in late August/early September, Europe has continued to make progress towards returning to normalcy.

Last week, European and IMF officials agreed to lessen the debt burden on Greece to ensure that, over time, the country can right its fiscal cliff. What’s more, this week Spain formally requested 40 billion euros in aid pledged back in June to recapitalize its struggling banking system.

That move is seen as further paving the way for an ultimate bailout request for the entire country — something the market has expected for weeks.

Interestingly, because of market obsession over the fiscal cliff here in the U.S., investors have ignored much of this progress. They are more concerned about selling dividend stocks and locking in gains over the last four weeks of the year. Many of them only see a European economy that remains mired in recession despite progress on the debt front.

And that could be an expensive mistake, because …

The most recent PMI report is giving a glimpse of hope that manufacturing in Europe is starting to turn upward.

There Are Recent Signs That Perhaps
Things Are Starting to Change a Bit

Economic data out over the past two weeks from Europe shows there are some “green shoots” emerging as the improvement in the sovereign debt crisis finally starts to filter through to the European economy.

Just this week, euro-zone PMI data revealed that manufacturing activity has stabilized. And although still showing that the sector in Europe is contracting, it looks as though the pace of that contraction has slowed. Additionally, recent sentiment indicators from Europe have also turned more positive, implying that some long needed optimism is moving across the continent.

Many investors don’t realize this, but taken as a whole Europe is the largest economy in the world. And the fact that the European economy is so weak has acted as a big drag on Asia’s export driven economies. But again there are some green shoots. Recent trade balance data from Europe showed imports holding their ground, implying consumer demand is bottoming.

This improvement hasn’t been lost on the European stock market …

Last week, the European STOXX 600, one of the most followed gauges of European markets, reached a 52-week high. To boot, Spanish 10-year bond yields and Italian 10-year bond yields have hit multi-month and multi-year lows respectively. This signals that concerns regarding a sovereign default in Europe have receded significantly since the early summer.

Now I’m not trying to say Europe is in the clear by any means — many challenges remain before the European economy can return to normal growth rates. But there are small signs of improvement in Europe. And if you are a savvy contrarian investor who can look beyond the short-term fiscal cliff hysteria, you may find an opportunity.

One way you could play a potential rebound in Europe is through the Vanguard European Index Fund ETF (VGK). This exchange traded fund tracks the performance of stocks in companies located in Europe’s major markets. And if the European economy can continue to turn around, these stocks could be the ultimate contrarian play.

Best,

Tom Essaye

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