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United States Vs. Europe

The largely followed European stock index is the Eurostoxx 50 which represents 50 blue-chip stocks from the countries participating in the European Monetary Union.  With the current Eurozone crisis, these stocks have been under heavy fire.  Both the S&P 500 and the Eurostoxx 50 bounced hard from their March 2009 lows to 60%+ recoveries in price.  The major difference is what happened in 2011:

The Eurostoxx have been blasted to within about 11% of their 2008 lows whereas the S&P 500 has held onto the majority of its gains.

The Eurozone is facing massive political headwinds, but at a dividend yield of 5.98% and P/E of 8.35, it looks relatively attractive versus the S&P 500’s 2.23% dividend yield and 12.71 P/E.  Will the Eurozone unravel in a spectacular way?  I doubt it, but to hedge your bets you could buy European stocks and sell US stocks in the prospect that the two will close their valuation gap.  If the Eurozone truly does blow up then you would expect a liquidity black hole in which the US equity market would follow in a downward spiral.  The risk is a further divergence in valuations or divergence in currencies.  The latter can be hedged away by a smart investor.

What seems to be a good facilitator for this trade is the Vanguard MSCI European ETF (VGK).  Current yield is 5.62% with a low 16bps fee, 13.7% exposure to European banks, and largest holding of 2.89% (Nestle).


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4 Responses

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  1. Stpepper says

    The logic is attractive, but I I was skeptical -I still am- of this trade, mostly because in the US the Fed has a lot of financial firepower and it’s willing to use it. The ECB on the other hand, probably doesn’t have the free rein the Fed has, and is not at this point willing to use the firepower it has. On top of that, I’m pretty sure the US can come up with quick emergency measures in the case of an European blowout while the European leaders will do another summit and after a week come up with another statement and then just do the minimum they think they can get away with.

    That said, the movements in the Euro Stoxx this recentlymuch vindicate you.

  2. SurlyTrader says

    You are correct that the ECB cannot legally bail out countries or financial institutions. It will take a change in the ECB’s charter to give them the power that the US Federal Reserve has. Today’s announcement that the Fed will provide dollar borrowing to the ECB basically says that the US Fed is willing to bail out European banks. So since the ECB is impotent, our own Fed has given out a helping hand.
    I do not agree with the move, which has smacked the dollar’s value against the Euro and tied us even closer to the situation in Europe.

Continuing the Discussion

  1. Further Reading: Michelangelo’s David vs the Drunken Moose Edition | Risk and Return linked to this post on September 13, 2011

    […] Trader wonders of the safe trade isn’t that European large caps outperform the S&P 500: The Eurozone is facing massive political headwinds, but at a dividend yield of 5.98% and P/E of […]

  2. Tuesday links: jack of all trades | Abnormal Returns linked to this post on September 13, 2011

    […] At what point does Germany become an attractive investment?  (Fund My Mutual Fund also SurlyTrader) […]

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