As Europe Slowly Heals, European Stocks Set to Outperform

The Greek debt crisis is back and the euro is tumbling. The Chinese economy continues to cool. Geopolitical instability reigns in parts of Eastern Europe and North Africa. And Japan’s economy continues to shrink.

As Europe Slowly Heals, European Stocks Set to Outperform

Given that backdrop, investors may be forgiven for thinking nothing has changed over the last four years, and in some ways in hasn’t. But as halting and incomplete as the global recovery has been over the last half-decade, the macroeconomic picture hasn’t been this bright in some time.

Things are getting better. Really. And that makes for some interesting implications for investing this year — particularly in Europe.

The wider continent and euro area have been duds for years, stumbling along with tepid growth at best and flirting with recession at the worst. Even the mighty economy of Germany — the engine of the eurozone — has been wheezing along. Gross domestic product expanded at less than a 2% annual rate for three consecutive quarters before jumping a surprise 2.8% in the most recent period.

True, the crisis in Ukraine and related sanctions against Russia — not to mention Russian counterattacks — have played havoc with the eurozone and any number of publicly traded companies. (Just ask adidas AG (ADR) [OTCMKTS: ADDYY] how it likes the conflict with Russia.)

But that geopolitical crisis is hardly all to blame for weakness in the eurozone. GDP in France hasn’t grown at more than a 1% annualized rate in years, well before Russia started bullying its neighbors.

European Stocks in the Spotlight

And yet European stocks haven’t looked this good in ages. The eurozone is showing faint signs of life, helped in no small part by the European Central Bank’s long overdue bond-buying program. Furthermore, European equities are one of the few global asset classes you can find that look cheap.

That’s why so many market strategists and economists are touting European stocks this year. Even Nobel prize-winner Robert Shiller — he of the housing index — is publicly considering forsaking U.S. stocks for their counterparts in Europe, largely because of valuation. For retail investors, the giant Vanguard FTSE Europe ETF (NYSEARCA:VGK) is a cheap and diversified way to gain broad exposure to European stocks.

Let’s assume that the impasse between Greece and its creditors comes to some sort of solution at the last possible moment, as these things tend to do. If that comes to pass, there are ample reasons for European stocks to keep outperform.

For one thing, if the ECB’s quantitative easing doesn’t prove to be too little too late, it should help get credit flowing again. After all, European banks have now been stress tested up the wazoo.

At the same time, the euro is at a 15-year low. Stagnant growth and deflationary pressures are a killer, no doubt. Just have a look at Japan over the last couple of decades. But the tumbling euro should help stanch any bleeding. It both boosts exports by making them cheaper overseas, as well as repatriated earnings collected overseas. (The opposite problem faced by U.S. multinationals.) Industrial companies and car manufacturers are loving what the weak euro is doing for sales.

The eurozone is still struggling with growth, but cyclical economic indicators have stabilized. Bank lending is picking up. The continent isn’t healthy, but the stage is set for gradual improvement in GDP.

As much as China may be the driver of the global economy, the importance of the Europe can’t be overstated. At roughly $18 trillion, the economy of the European Union is the largest in the world.

Stocks, of course, are forward looking. European bourses are rising this year ahead of economic improvement. And a healthier Europe should eventually help U.S. stocks, as well commodity prices.

After all, the continent is a fountain of demand when it’s not falling apart.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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