I’ll share a secret with you. My academic background isn’t finance. Originally, I was trained as a historian and in my professional opinion; Europe has been a mess since the fall of the Roman Empire.
The fact that a monetary union was born without an underlying political union has repeatedly led many pundits to predict eventual failure for the European Union (EU). But, love it or hate it, it’s here to stay.
Of course, since the financial crisis of 2008, Europe has been experiencing a series of economic crises, most recently the sovereign debt crisis of 2011-2012. And austerity imposed by Northern European countries upon Southern European countries has led to ongoing economic weakness ever since.
Recent years have been marked by shockingly high rates of unemployment -- especially among Europe’s youth -- and ongoing social unrest. Even mighty German is now feeling the effects, slashing its 2015 GDP growth outlook by 35% to 1.3% from 2%.
Now, as the eurozone economy faces deflation, European Central Bank (ECB) president Mario Draghi has committed to a policy of quantitative easing (QE) worth at least 1.1 trillion euros ($1.3 trillion). The design, like the Federal Reserve’s QE program, is to provide sufficient liquidity to European financial markets and stimulate the Eurozone economy.
But can it work? There are a couple differences between U.S. QE and EU QE:
--The U.S. Federal Reserve purchased U.S. treasury securities and other related bonds, such as mortgage backed securities, directly from banks. The goal was to get banks to start lending and stimulate the economy. Under the ECB’s direction, the central banks of the Eurozone’s 19 member countries will make 80% of the purchases with the ECB shouldering the rest. That means that Mario Draghi has had to act like an orchestra conductor, trying to get everyone on the same page.
--On the other hand, 80% of the risk of holding the bonds is spread across multiple players. Therefore, should a country, Greece for example, default, the blow may be sustainable. All of the risk associated with the bonds purchased in the Fed’s QE fell on the Fed. While the central bank would have had penultimate discretion on how to value the Treasury’s bonds in the event (or cataclysm) that there was a default by the U.S. Government, who knows what could’ve happened.
Draghi has his work cut out for him. Many pundits say that the Europeans have hemmed and hawed and that the EU should have taken action much sooner. Still, throwing more than a trillion euros at a problem should have some positive impact.
Any kind of large capital infusion will move markets. And when markets move, there’s money to be made. Here are three sectors that should benefit the most:
Big European Banks
The initial beneficiaries of QE are always large financial institutions. Central banks buy bonds from them for cash. Just looking at simple market mechanics, wide scale bond buying tends to drive up prices so most selling institutions will realize profits on their positions. Eventually, this should flow through to earnings.
Although still off 15% from its 2014 peak, the iShares MSCI Europe Financial Sector ETF (Nasdaq: EUFN) has bounced nearly 4% since Mario Draghi fired his monetary bazooka.
Two stocks I like in this sector are Deutsche Bank AG (NYSE: DB) and French bank Credit Agricole S.A. (OTC: CRARY).
Deutsche Bank has a gigantic global footprint across all financial services platforms and its shares look dirt cheap. At around $28.50, the stock trades at better than a 40% discount to its 52-week high and at just 50% of its tangible book value. The forward price-to-earnings ratio of 13 and its 3.3% yield is also attractive.
With more than $2 trillion in assets, Credit Agricole has one of the largest retail franchises in France with earnings per share and revenue growth rates that clobber larger rivals like J.P. Morgan Chase &Co. (NYSE: JPM). I profiled the company in greater detail last year.
As economic stimulus is the goal of any central bank’s QE program, car manufacturers typically benefit when big ticket spending returns. There’s also benefit from a weaker euro in the export market. The best play for this would be automaker Volkswagen AG (OTC: VLKAY).
To be sure, Europe’s QE program will have an uncertain impact on domestic auto demand. The real benefit for these auto makers is the weaker euro and its impact on exports. VW’s luxury brands, such as Audi, Porsche, Lamborghini and Bentley, should see margin gains from the euro’s weakness.
Shares of VW have bounced a bit with the recent QE announcement but are still 14% off of last year’s highs. At $45.50, shares trade with a bargain forward P/E of 8.8 and an attractive 2.4% dividend yield.
High End Luxury Goods
Keeping with the weaker currency-stronger exports theme, manufacturers of consumer luxury goods should do quite well.
The idea is twofold. Sales of goods exported from Europe should get a boost from the weakened euro as their retail prices become a bit more competitive in export markets. On the continent, sales should rise due to increased tourism. A weaker euro makes a European vacation more attractive for foreign tourists. Look for those tourists to bring home a pricey souvenir or two.
The best idea for this sector would be luxury consumer goods powerhouse LVMH Moet Hennessy Louis Vuitton SA (OTC: LVMUY).
From top-drawer leather goods and watches to top-shelf liquor, LVMH’s portfolio is perfectly primed for the well-heeled global consumer. Brands include Hennessy cognac, Christian Dior, Hermes and TAG Heuer.
LVHM’s annual sales growth has averaged 5.7% over the last three years, which is respectable for a consumer discretionary company in an extremely challenging economic environment. Like the other sectors covered, LVMH got an encouraging bounce with the announcement of EU QE, but still trades at an 10% discount to its 52-week high. Shares are priced around $33 and have a 1.9% dividend yield.
Risks To Consider: Again, EU QE will be much different from that in the United States. Draghi must successfully navigate a coordinated effort where the Fed just had to press a button. Also, if the goal is to keep interest rates low to spur borrowing, how much lower can European rates actually go? The German 10-year bund yields are currently below 0.35%, while French 10-year yields are hovering in the half a percent area. The strongest advantage LVMH, VW and Deutsche Bank have are their huge, global franchises.
Action To Take --> From the second round of QE announced by the Fed in July of 2011, the S&P 500 has posted average annual total returns of nearly 15% and the U.S. economy is growing at a moderate, yet consistent, pace. I think European markets are primed for similar returns. The average dividend yield for the stocks mentioned is 2.5%. Combined with a similar return, average annual total returns would comfortably approach 20%.
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