The U.S. stock market is on pace for a great year with the S&P 500 already up 16% and over three months left in 2012. Meanwhile across the pond the European markets are quietly putting together a bull market of their own. The Frankfurt DAX in Germany is up 25% and even the troubled country of France has seen its index, the CAC 40, gain 12%.
With the valuation of the U.S. stock market below its historical average there can be a case made that the S&P 500 should continue to do well into next year. I agree with that argument, especially considering the latest round of quantitative easing will likely boost asset prices including equities. In the same argument an investor that is looking for value should also consider the European markets.
Value in Europe or Value Trap
The P/E ratios for most of the European countries are at levels that well below their historical averages and are flashing buy signals for the risk-taking value investors. I say risk-taking because typical value investing is not considered overly risky. However, given the situation in Europe and the fact no clear plan has yet to be established to right the ship, the risk is higher than a typical value investment.
The nay sayers in regards to Europe will call it a value trap, suggesting that even though valuations are attractive, that it is not yet time to invest in the region. The valuations could be based on unrealistic future earnings and make the countries look attractive when in reality they are overvalued. There are also the risk factors that will directly affect how a country is valued. The higher the potential risk to the future earnings and stability of a country, the lower the valuation should be at current levels.
The broad based iShares S&P Europe 350 Index ETF (NYSEARCA:IEV) is up 12% in this year and came within one percent of a new 52-week high last week. The ETF has over 350 stocks based in Western Europe with a heavy concentration on the UK (35%) and France, Switzerland, and Germany each making up 13%. The financials, even after the beating they have taken, remain the largest sector represented with 19% of the allocation. The ETF charges an annual expense ratio of 0.6% and the current 30-day SEC yield is 2.9%.
Breaking down Europe into regions finds that the Nordic countries have been some of the best performers in 2012. The Global X FTSE Nordic 30 ETF (NYSEARCA:GXF) is up 23% for the year and recently hit a new two-year high. The ETF invests in four countries, Sweden (47%), Denmark (21%), Norway (20%), and Finland (11%). The financials make up a large portion of the ETF at 28%, however that is not as much of a concern as many of the regions banks have been able to hold up better than the rest of the continent. There is risk in that the issues that plague the Southern parts of Europe will eventually spread to the Nordic countries, but the fact they have yet to do that makes the odds low. The ETF has an expense ratio of 0.5%.
Investors looking to take on more risk and pick a specific country could consider one of the original PIIGS. Ireland has turned the corner and the focus in the European Union is now on Greece, Spain, and Portugal. Ireland may not be completely out of the woods, however with a P/E ratio of 9.7, according to the Financial Times, the country is considered a value play. The iShares MSCI Ireland Capped Investable Market ETF (NYSEARCA:EIRL) is having a great 2012, up 21% and not far from its best level in years. The one issue I have with EIRL is the concentration of its top holdings. CRH Plc (NYSE:CRH), a cement company, makes up 23% of the ETF Kerry Group Plc accounts for another 12%. When two stocks make up over one-third of an ETF it should be a red flag that diversification is no longer a factor.
Weighing the Risk
With the risk that is taken by investing in European ETFs before the situation is rectified comes greater than average reward potential. Investors must be able to look themselves in the mirror and realize by investing in Europe today they must have a long-term horizon and willing to ride out the likely volatility. If that is not doable, then forget everything you just read.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.