Eurozone Forecast: How to Profit From the Hidden "Good News" in Europe

[Editor's Note: This special report on the Eurozone economy is part of Money Morning's annual "Outlook" series, which will forecast the prospects for commodities, U.S. stocks and other top profit opportunities in the New Year. Make sure to watch for upcoming installments in the days and weeks to come. Click on the "Outlook 2011" logo to see past installments.]

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If you wanted to describe how most of the European nations fared in 2010, you would do so quite easily by citing the old adage: "If it wasn't for bad luck, they'd have no luck at all."

Truth be told, Europe was in the news for most of 2010 – but for all the wrong reasons. A series of financial panics hit the weaker Eurozone countries hard, forcing draconian austerity measures in many countries and igniting concerns that the euro may not survive as a currency.

Against such an unappealing backdrop, it's no real surprise that any positive information tends to be overlooked.

And that's truly unfortunate, since for much of Europe – and for its stock markets – 2011 should be a pretty good year.


Better Than It First Appears

Money Morning Outlook 2011

For 2011, the team of forecasters for The Economist is projecting 1.3% growth for the Eurozone (the 16 out of 27 EU countries that use the euro currency). At first blush, that appears to be decidedly inferior to the projected U.S. growth rate of 2.3%.

But it's not that simple: You must also factor in the reality that the Eurozone's annual population growth is only 0.1%, versus 1.0% in the United States. Once you do that the growth rates are almost identical – 1.2% in the Eurozone versus 1.3% in the United States.

What's more, the overall European rate of growth masks some big divergences between countries.

For instance, Europe's overall performance is being held back by a group of underperformers, whose economies are growing slowly, or even declining. For instance, Greece's gross domestic product (GDP) is expected to decline 3.6% in 2011. Other laggards (with their GDP growth/decline rates in parentheses) include Portugal (minus 1.2%), Italy (plus 0.9%), Italy (plus 1.0%) and Spain (plus 0.4%, an estimate I believe is highly over-optimistic).

In those countries, the austerity necessary to remain members of the euro community will cause some real economic pain. Factor those out, and it's clear that Europe contains some real bright-spot economies.

When East Pursues the West

As has been the case for the past decade, the best growth rates continue to be among the countries of Eastern Europe. Those economies are still catching up to their Western counterparts in terms of their living standards, and are often more-free market in their orientation.

Poland is expected to grow at a brisk 3.8% pace. Latvia and Slovakia are both expected to post growth rates in excess of 3%. And the economies of Lithuania and Estonia will each advance at rates approaching 3%.

When the recession hit in 2008, these countries were expected to do particularly badly – with Latvia, Estonia and Lithuania written off as basket cases. As it's turned out, however, after a horrendous 2009 that saw their GDPs dropped by more than 10%, all three Baltic states are now rebounding nicely – as is Slovakia.

Poland, whose currency was not linked to the euro, was able to absorb recession through devaluation. It's now racing ahead even faster.

There have been some losers, however – those countries of Eastern Europe that were genuinely badly run. One example: Hungary. Growth is expected to be only 2% and debt levels are dangerously high.

Engine of Growth

Last but not least, there is Germany. The Economist panel is projecting growth of only 2%. But that's almost certainly another example of Anglo-American economists underestimating Germany's real potential. Its growth rate in 2010 is actually expected to be 3.3%.

Germany now has a substantial labor cost advantage over its neighbors in the euro community, and is growing relatively rapidly, as the costs of absorbing the former East Germany fade into the past.

As was the case back in the 1980s, Germany is one of the world's great growth economies, with a structural trade surplus due to the efficiency and quality of its manufacturing. The euro, holding down Germany's exchange rate through the inefficiencies of its European neighbors, only accentuates this trend and increases Germany's growth potential.

As an investor, your portfolio needs exposure to Europe; it's a huge part of the world economy, and growth and profitability in the better parts of Europe are highly satisfactory.

However, not many European companies are readily available to U.S. investors these days: As we warned you about several years ago, the expensive Sarbanes-Oxley registration requirements have driven many of them to cancel their Big Board (New York Stock Exchange) listings. That means that your best bets are one or more of the attractive-country exchange-traded funds (ETFs) that are available.

Actions to Take: Investors need to have capital deployed in Europe. It's a huge and very-key part of the world economy, and growth and profitability in the better parts of Europe are highly satisfactory.

Exchange-traded funds may be the most effective ways to do this. Choose one or more from this list:

  • iShares MSCI Germany Index Fund (NYSE: EWG): This ETF covers Germany, currently Europe's strongest economy, an export dynamo recovering rapidly on the basis of some of the world's soundest economic policies. At $1.6 billion, with a 0.55% expense ratio, a Price/Earnings (P/E) ratio of 11 and a yield of 1.4%, this fund should be a core holding of any portfolio, even if other investments are mostly domestic.
  • iShares MSCI Sweden Index Fund (NYSE: EWD): Americans tend to think of Sweden as a dozy, socialist economy, but it has actually revived itself considerably in the aftermath of a horrid crisis in the early 1990s. While not ignoring the tragic events of this past weekend, it's important to note that the World Economic Forum has recently rated Sweden as the world's second-most competitive economy, ahead of the United States (which is in fourth place). EWD is a $250 million fund, with a low 0.55% expense ratio; the P/E is a bit higher at 15, though the fund's yield is a respectable 2.1%.
  • iShares MSCI Eastern Europe Index Fund (NYSE: ESR): This is a small fund, at only $14 million, but it gives you access to the growth areas of Eastern Europe, where it is very difficult for U.S investors to invest directly. Its expense ratio is a slightly higher 0.70%, but its P/E ratio is only 10. And we all know that a low P/E and a higher growth is more often than not a winning combination.

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  1. Michael Monro | December 14, 2010

    Good article Martin. Thanks for the heads up on Europe and the three ETF's that you listed.

    Best regards,

    Michael Monro

  2. Bill Goode | December 14, 2010

    I don't believe this for a second. Statistical analyses typically ignore cause and effect. Riots are occurring all across Europe. None of the governments that are facing these riots are able to handle the basic issues behind the rioting. All that has happened is the institution of more controls.

    The European people generally hold the belief that it is government's job to take care of them. Their governments are only beginning to falter in that regard. The debt to GDP ratio in every country is not sustainable, yet the ratio is increasing as the people demand the services they expect. Serious social unrest is only beginning. So far people have only been rioting against not receiving their expected level of income. When their incomes drop to the level where they can't buy food, then serious rioting will start.

    If you are going to use statistics, just look at the debt to GDP ratios of the various countries and compare them over time. What were the debt to GDP ratios ten years ago? Was their rioting then? No there wasn't. The governments started promising more services and their ratios increased beyond sustainable levels. Now there is rioting and those promised services that were promised (and paid for by the people) are being withdrawn.

    How can economies grow in such a scenario? It won't happen. Mr. Hutchinson should rely more on cause and effect than on statistical analyses.

    • Jeff Pluim | December 14, 2010

      Well said Bill. I usually agree with Martin, because he usually sees the big picture. I'm sure that when he reads your perspective, he will adjust his forecasts accordingly.

  3. JoAnne Ryan | December 14, 2010

    Are the last two comments for real or are they kidding? I agree that some of europe has peoblems with entitlements but not all as martin pointed out. Martin Hutcheson knows what he is doing as my profits from his two portfolios clearly point out.I am quite sure he does not need your cause and effect strategy to recommend picks as my portfolio is way up without you helping him pick. You would do well to buy his services follow exactly and make a great profit like i am! Joanne

  4. courtier-or | December 15, 2010

    @ Bill Goode and @ JoAnne Ryan

    By my opinion, you’ve got reason in many points. Nevertheless, I still believe in the right-sight throughout global orientation of Martin’s analysis.
    Some reasons are really interesting to point out:

    1) Martin is talking about STOCKS!

    Even the financial neophyte is now aware about the risks of bonds and knows the direct relationship between financial bailouts and stockmarket variations.
    “Seine bolschevistische kamerad “Angela Merkel has recently confirmed his determination to save situation through ECB bonds buying and financial bailing. This confirmation is makes me certain to see the euro sink next year. Saving the German economy will unavoidably cost euro at the end, but who cares? Euro is ever sentenced to death and Germans are on the blocks to use this demise adequately.
    See the WSJ Asian edition of 14th this month and the article of ECB easing to understand more than well, what’s really happening.
    European stock market will also unavoidably benefit from this situation, so for Germany and for his satellite economies at first: Slovakia is one of them, for sure!

    2) The political situation in Europe is really faltering

    Yes, you’ve got reason! But don’t forget that all the recent demonstrations aren’t really comparable to civil unrests troubling economies in any way.
    The Prince is scare stiff about Britons? Let the degenerate live his fears! What is the damage for the economy? Strictly nothing!
    The same thing is happening in continental Europe, where the people are more civilized (By two lost wars of XX century, to put it bluntly). Some outlets devastated and some riots under tight police control? Who cares? The European citizens aren’t allowed to purchase weaponry and still under pressure of unemployment. Individually, they accept well lowing levels of wages. Their economy stills running.
    The printing press and the restored competitiveness of the European workforce will avoid sinking of European stockmarkets in 2011.
    Once more: In the long way you’re certainly right, but in 2011 it’s too early to see the political establishment of the UE knockout.
    I believe, that the investing in European stocks, (Exportation oriented economies will be certainly more interesting than the intermediate ones …) will avoid you to lose your money in 2011.

    For 2012 I’m less optimistic! The destiny of all global marketplaces as economical entities can be under threat. Maybe a turning point, wait and see.
    P.M.

  5. Niels Christensen | December 15, 2010

    I live in Europe (Denmark) and I dont think that we have any more riots today than 10 years ago. How the economy is going is most likely dictated by Rothchild, Rockefeller and Co. just like in the US.

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