Europe is slowly moving toward closer integration. If done correctly, this should be supportive of European risky assets, but there is still considerable work to be done, particularly in bringing together Europe’s fragmented banking system. While this is still in a work in progress, we continue to focus our European exposure on Germany, the Netherlands and Norway.
Over the past month, a lot has gone right in Europe. That said, it’s important to emphasize that Europe is not out of the woods, and the major structural reforms have yet to be implemented. In general, we see three main areas where European politicians need to deliver:
- Tighter fiscal integration, which will ultimately involve some pooling of debt;
- Labor market reforms – especially in southern Europe – which are necessary to make those economies more competitive, and
- Banking reform is particularly important. Europe needs to move toward a single European bank regulator and Europe-wide deposit insurance in order to stem the bleeding of deposits from southern European banks.
Even if these reforms are ultimately successful, they will take time. Meanwhile, we’re still cautious about southern Europe, but we continue to hold a constructive view of many northern European countries, where the economies are on firmer footing.
We came into the year with overweight views on Germany and the Netherlands. Germany has been a stellar performer so far in 2012, up over 24%, roughly double the return for US equities. Stocks in the Netherlands have also posted a significant rally, up 14% so far this year, in line with a broader global benchmark.
Finally, in late January, we added Norway to our list of northern European favorites. Our view on Norway was driven by several factors, including its currency that’s independent of the euro, strong economy, high dividend yield, and exposure to the energy sector. Since the beginning of the year, the Norwegian equities have appreciated by over 14%.
Despite strong-year-to date gains, all of these markets still appear reasonably priced. All three are trading for roughly 10 times forward earnings, a significant discount to US equities. Finally, for yield hungry investors, all three of these markets are currently yielding well above 3%, and over 4% in the case of Norway.
So for now, while Europe’s long-term trajectory still remains a bit of a question mark, we’d stick with our northern European theme and remain overweight on Germany, Netherlands and Norway. These can be accessed by the iShares MSCI Germany Index Fund (EWG),the iShares MSCI Netherlands Investable Market Index Fund (EWN), and the iShares MSCI Norway Capped Investable Market Index Fund (ENOR).