Best International Investment for the Second Half of 2015: Europe

American stock prices have barely budged in six months. With valuations stretched, economic data mixed and all eyes watching the Fed, there hasn’t been much news to send the market higher. But overseas, we have a very different story.

quarterly review and outlookEuropean stocks, as tracked by the Vanguard FTSE Europe ETF (VGK), are up more than 6% year-to-date, and I believe the big move in European stocks is only just beginning.

Let’s start with the macro picture. American GDP actually shrank in the first quarter, and it’s not necessarily looking robust in the second. We might avoid technical recession, which would mean GDP contacted for two consecutive quarters, but that’s hardly a rousing endorsement of economic growth.

For the full year, forecasts have been drifting lower, with the consensus now at 2.1% for the year.

Meanwhile, after years of sluggish growth and a lingering sovereign debt crisis, Europe is actually growing at a halfway respectable clip. European Union GDP is forecast to grow 1.8% this year and 1.9% in 2016. And GDP in some of the hardest-hit countries — such as Ireland and Spain — is forecast to grow at an even faster clip. The Irish economy is forecast to grow by 3.6% this year, and the Spanish economy is forecast to grow at 2.8%.

Why Europe Is More Promising

Hold on now … why do I seem more excited about 1.8% growth in Europe than 2.1% growth in the U.S.?

It’s all about recent history and expectations. Unlike the U.S., which had a deep recession in 2009 followed by a sustained, if somewhat choppy, recovery, Europe had that rarity that economists like to talk about but rarely see in the wild: A double-dip recession.

After recovering modestly in 2011, the European economy spent most of 2012 and 2013 contracting. For the U.S., 2% growth is a disappointment and no justification for lofty stock market valuations. In Europe, near-2% growth is a massive improvement and a cause for celebration.

Now let’s talk valuation. European stocks are not the bargain-basement values they were in 2012, but they are far from expensive. The major markets of Europe trade at cyclically-adjusted price/earnings ratios (“CAPE”) between 9 and 18 and are priced to deliver annual returns of 7%-9% over the next several years. In contrast, U.S. stocks trade at a CAPE of over 25 and are priced to deliver flat returns at best.

Lower valuations and lower expectations (and thus room for positive surprises) are a recipe for outperformance. Sounds good. But what could go wrong?

Well, to start, there is that little … ahem … “issue” in Greece. Greece may well be forced into default within weeks, and it is unclear how this might play out.

The ECB has been planning for this eventuality, and it’s entirely possible that a Greek exit can be contained. Of course, it’s also possible that a it will start a domino effect that leads to the unravelling of the eurozone.

My bet is that Greece, by hook or crook, manages to avoid default. But any market turbulence that happens in the meantime could present a nice buying opportunity.

In particular, I would look for any sharp selloffs in Spanish stocks. With the Spanish economy recovering — and with Spanish stocks still among the world’s cheapest — the iShares MSCI Spain ETF (EWP) is already a solid value. Add in temporary crisis pricing, and you have the pieces in place for a fantastic trade.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. As of this writing, he was long EWP. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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