Friday's ETF to Watch: European Financials

| About: iShares MSCI (EUFN)
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After a rough day in the markets on Wednesday, equities soared on Thursday as investors cheered the results from a host of companies who reported a strong quarter and managed to increase earnings by maximizing top line growth instead of cutting costs. Among the biggest gainers on the day was industrial manufacturer Caterpillar (NYSE:CAT) which raised guidance for the second half the year, while pharma giants Eli Lilly (NYSE:LLY) and Bristol-Myers Squibb (NYSE:BMY) reported strong earnings and revenue growth as well. Mike Lenhoff, chief strategist at Brewin Dolphin, said:

The market is struggling between a message from the Fed that is slightly discomforting and earnings that are coming which have been quite decent in the U.S. and Europe.

Despite a solid day in the markets which saw most indexes jump by more than 2%, uncertainty remains in the world economy. One of the biggest question marks thus far in 2010 has been in the eurozone, where banks appeared to be on the brink of disaster before a near trillion dollar bailout came to their rescue in order to protect some of the continent’s largest banks from sovereign debt losses.

These European banks look to be especially in focus as stress test results are released sometime today; initial reports called for the test results to be released after the bell in Europe on Friday but now there is growing speculation that the tests could be released before European markets open. Although the timing is uncertain, the number of banks in the report is not; 91 banks will have their results published by the Committee of European Banking Supervisors with most expected to pass the test. In a report by KBW according to CNBC, 10 banks are likely to fall below the 6 percent Tier 1 ratio and would need to raise 9.8 billion euros ($12.5 billion) in order to meet the capital requirements. Obviously, this is a relatively small number and it suggests that European banks could be in decent shape going forward.

(image: Clive Power / However, many are not very optimistic about the process suggesting that it is more of a charade than anything, and is intended to boost confidence among investors and other market participants. Macquarie analysts said on Wednesday:

With too few banks likely to be identified as capital-deficient and too little additional capital being pumped into the banking system, it seems unlikely that current fears will dissipate.

No matter what happens in the report later today, it is likely to be a turbulent trading session for the troubled European financial sector as the results and implications are fully digested by investors.

For these reasons, we have selected the iShares MSCI Europe Financials Sector Index Fund (NASDAQ:EUFN) as Friday’s ETF to watch. The fund tracks the MSCI Europe Financials Index which is a free float-adjusted, market capitalization-weighted index designed to measure the combined equity market performance of the financials sector of developed and market countries in Europe. Component securities include those of banks, diversified financial companies, insurance companies, and real estate companies. The fund holds 115 securities in total but it has close to half its assets in its top ten holdings suggesting that the fund is heavily concentrated in a few large cap names. In fact, the top four holdings, HSBC (HBC) (12.6%), Banco Santander (STD) (6.9%), BNP Paribas (OTCQX:BNPQY) (4.1%) and Standard Chartered PLC (3.9%) combine to make up just over one-fourth of the total assets of EUFN. In terms of individual country exposure, non-euro members take the top two spots with the United Kingdom making up 31.5% of the fund and Switzerland trailing with 12.1%. The four major euro zone countries are next with France, Germany, and Spain each making up about 11% and Italian securities taking up 7.7% of the fund. Since its inception in early February, EUFN has fallen by close to 11% as sovereign debt fears and austerity measures caused many investors to believe that growth opportunities would be severely limited for the foreseeable future. However, EUFN has done much better as of late; the fund soared by more than 4.5% in yesterday’s trading and looks to continue that gain after today’s crucial stress test announcement.

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Disclosure: No positions

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