In a key meeting this month, the European Central Bank issued a “steady as she goes” policy on continental interest rates, with no apparent movement on rates for at least another year or two.
“With no changes to the ECB’s policy sequencing under discussion, the guidance now means that rates will not be raised until after the end of asset purchases, which is likely to be late 2018 or early 2019 at the earliest,” Lena Komileva, chief economist at G+ Economics, in London, says in a research note.
The ECB, which sets monetary policy for European countries, comparable to Federal Reserve Bank in the U.S., has generally mirrored the Fed’s interest rate policy since the great recession of 2007 and 2008, says Tenpao Lee, professor of economics at Niagara University in New York.
“More specifically, the ECB’s monetary policy has been consistent with Fed’s three phases of quantitative easing with a time lag,” Lee says. “Now, we have stopped the three phases … and the ECB is beginning to follow the Fed’s policy to end its QE policy in the near future.”
Lee says that overall, the progress of eurozone’s economy is comparable to the conditions of the U.S., with low inflation, low interest rates, a record high stock market and low unemployment. “Also, the euro has been generally strong in this year, as its value has increased about 13 to 15 percent this year,” he says. “A higher euro will hurt its export and economic growth.”
[See: The 10 Best European Stock ETFs on the Market.]
There are several scenarios, going forward, that could impact rates and the European economy. “If the ECB maintains its QE policy, the euro will be either stable or weaker, which will help its export and economy,” Lee says. “If the ECB stops QE immediately, the euro will be stronger and hurt its export and economy.”
The stock market prefers certainty rather than uncertainty, lower interest rates and lower currency value. “Most likely, the ECB will gradually stop its QE policy to meet market expectations,” Lee says. “We expect that ECB will not stop buying bonds right away and will send a signal to stop QE in the future.
What European investment categories does Lee like? Given the ECB’s consistent rate policy, financials could be a winner for investors.
“Interest rates at historically low, even below zero,” he says. “We expect that ECB will gradually stop its easing policy and that interest rates will be higher in a year or two. Therefore, banking stocks will be better off and the REIT/real estate sector will be hurting.”
Exporting companies will be less attractive than importing companies, he says.
Yet Lee doesn’t advise U.S. investors to steer cash across the Atlantic.
“The ECB’s policy is not certain yet,” he says. “Therefore, we don’t recommend moving too much money to European markets. However, to diversify your portfolio, we recommend buying banking stocks and biotech stocks. Biotech stocks are less affected by ECB policy, while banking stocks can benefit higher interest rates.
[See: 10 Ways to Buy International Small-Cap Stocks.]
“If the U.S. economy really is a mirror of European countries, the American banking sector and biotech sector have been doing well after the Federal Reserve stopped its policy of quantitative easing,” he says.
Other eurozone watchers say the continent’s financial markets offer significant value to outside investors these days.
“In terms of relative valuation, considering price-to-earnings ratios, all major European markets sell at a lower price-to-earnings ratio than the U.S. Standard & Poor’s 500’s P/E ratio of 24.54, on a trailing 12-month earnings basis,” says Robert Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pennsylvania.
For an apples-to-apples comparison, if one simply looks at the P/E ratios on iShares European country indexes, then all European markets sell at a discount to the broad U.S. market. “P/E ratios on European country funds range from a low of 13.09 on Austria to a high of 24.19 on the U.K.,” Johnson says.
“The overall European index offered by iShares (the iShares Europe exchange-traded fund, ticker: IEV) currently has a P/E ratio of 19.7, representing an approximately 20 percent discount from the broad U.S. market,” Johnson says. “That represents a substantial discount and likely will provide investors with a larger margin of safety compared with investing in the broad U.S. market.”
[See: 7 Socially Responsible ETFs for Investors of All Stripes.]
Currently, the iShares European ETF is trading at $46, and is up a sturdy 19 percent on a year-to-date basis. With the ECB keeping a steady hand on the keel, look for European stocks to keep growing — and look for more cash flowing in from the U.S. and Asia, as investors look to both diversify and profit from a burgeoning European economy.
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ECB Maintains Rate Policy: How That Impacts European Stocks originally appeared on usnews.com
