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Two ETFs You Should Own

The worst of the European crisis has passed. While many of the overleveraged countries on the continent still have major problems to solve, the European Central Bank’s actions last year have succeeded in keeping the monetary union together. And with uncertainty surrounding the eurozone’s fate removed, European equities are already...

The worst of the European crisis has passed. While many of the overleveraged countries on the continent still have major problems to solve, the European Central Bank’s actions last year have succeeded in keeping the monetary union together. And with uncertainty surrounding the eurozone’s fate removed, European equities are already making up the ground they lost as fearful investors chucked them during the height of the crisis.

Further European stock gains will come in response to hard data on economic growth and improved corporate performance as consumer confidence improves and earnings grow.

The easiest way to play a broad European rebound is with exchange-traded funds, or ETFs. Conservative investors will like the SPDR Euro STOXX 50 (FEZ), recently recommended in the Dick Davis Dividend Digest by Moneyletter Editor Walter Frank. As Frank explains in his recommendation, below, the Dow Jones-like fund is a good play on the growth of the overall European economy and its largest companies:

“Sitting high among Moneyletter’s top-ranked international stock funds, SPDR Euro STOXX 50 (FEZ) has recently been added to the Moneyletter Venturesome, Moderate and Select Model Portfolios. At the end of 2012, it was sporting the best six-month return in the international group. …

“The SPDR Euro STOXX 50 provides exposure to the largest blue chip stocks in the Euro market. Specifically, the fund tracks an index of the same name, investing in Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. (The fund is not to be confused with the SPDR STOXX Europe 50, symbol FEU, which invests in blue chips from these 12 nations plus six more: Denmark, Iceland, Norway, Sweden, Switzerland and the U.K.)

“The Euro STOXX 50 is further designed to select companies ‘across components of the 20 Euro STOXX Supersector Indexes.’ These basically represent the major sector categories such as health care, information technology, energy, etc. At 25.3% of total assets, the financial services sector is by far the most heavily weighted in the fund, and is significantly above the Morningstar Europe stock category average. The fund is also overweight in the smaller utilities sector, while slightly underweight its category in energy and industrials.

“It’s noteworthy that this fund excludes stocks from the U.K. and Switzerland, which are among the largest stock markets in Europe. The two are also among the more stable markets, having weathered the financial crisis better than most. That also means the fund has a greater exposure than most of its peers to some of the weaker nations, such as Spain and Italy. Similarly, the fund’s hefty financial weighting increases risk at a time of weak sovereign debt quality, high loan losses and rising capital requirements.

“So the fund courts more risk than its typical peer. But as we know, the assumption of added risk can work to both the downside and the upside. In 2009 and 2010, during the depths of the European financial crisis, the fund’s performance was near the bottom of its category. Last year started out positively, with strength in the fund’s information technology, auto-related and consumer discretionary shares leading the way. But the second quarter was a completely different story as the financial sector took a hit, as did materials and industrials due to unease in the European region. The fund returned to superior returns in the last half of the year, with financial firms swinging upward as confidence grew in the banking system. The fund finished the 2012 year in the middle of its category.

“The positive momentum that emerged in the last half of 2012 is carrying over to early 2013. Financial services firms continue to lead the charge, with banks BNP Paribas and Banco Bilbao Vizcaya Argentaria posting strong results, along with insurers Allianz, ING Group, and AXA. SAP (enterprise software) has been strong for the past year, as have automakers Volkswagen and Daimler, and luxury goods maker LVMH Moet Hennessy Louis Vuitton. Bayer has been another standout as it is benefiting from Japanese approval for a new drug to treat wet (exudative) age-related macular degeneration. Overall, the fund should be a good way to capitalize on recovery and increased stability in the Eurozone.”—Walter Frank, Moneyletter, January 11, 2013

So while conservative in its stock selection, the STOXX 50 fund is a fairly aggressive play on European recovery because of its focus on the most beaten-down European countries, and exclusion of the relatively unaffected U.K. and Switzerland.

However, true bargain hunters may have noticed that FEZ has already appreciated about 25% since the height of the European crisis last summer. If you’re looking for something more unloved, with a deeper discount, you might consider this ETF recommended by Investor’s Digest of Canada contributor Keith Richards in the latest Dividend Digest:

“Compared with the SPDR S&P500 ETF (SPY), the Vanguard MSCI Europe ETF (VGK) trades at a discount on all metrics, while offering a slightly higher dividend yield. It offers a dividend yield of over 3%, given that it now trades at 11.6 times its forward earnings, and trades at 1.3 times its book value. By contrast, the S&P 500 sports a forward P/E of 14, a price-to-book ratio of 2 and a dividend yield of just over 2%. Charts show the Vanguard fund, as well as Europe’s STOXX 50, an index of the Continent’s leading blue chips, are breaking significant technical resistance, suggesting further upside for contrarian investors.”—Keith Richards, Investor’s Digest of Canada, February 15, 2013

A third way to play a European recovery is to buy shares in individual European companies, many of which are recovering from the crisis more slowly than sector funds and thus offer better value here. Plus, good stock pickers can try to choose companies that will benefit from the second European catalyst, economic growth and improving revenues, much sooner than the continent as a whole. As Roger Conrad wrote in the latest issue of Personal Finance, “Europe’s biggest names are no longer on sale.

The STOXX Europe 600 Index (akin to the S&P 500) is up about 25% since mid-2012, when it became evident the euro zone wouldn’t implode. Given uncertain economic growth in Europe and the U.S., the better deals now are among midsize European companies that enjoy a catalyst for growth.”

I can’t share his individual stock picks with you here, but one of them was recommended in the latest Dividend Digest. If you’re interested in playing the European recovery with individual stocks, why not take a trial subscription now and see what you think?

For details, click here now.

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Investment of the Week

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.