With U.S. national debt increasing, unemployment rising and fears of a dipping dollar brewing, the veil of market uncertainty is quickly widening for investors.
Fixed-income investors in search of yield find themselves struggling in the near-zero interest rate environment. This may motivate them to look for opportunities in European equities.
The European Central Bank passed a stimulus plan last month to help trigger economic growth in the eurozone, which has supported Europe’s markets, while the U.S. Congress has yet to agree on an emergency aid package.
Apart from the ECB’s support, there are a variety of reasons the European market may be appealing.
For diversification purposes alone, investors should recognize European equities as part of their portfolio in part because of a positive market outlook, unique characteristics, and good valuations without compromising quality:
— How to evaluate European dividend-paying stocks.
— European market vs. U.S. market.
— Market outlook: long term vs. short term.
How to Evaluate European Dividend-Paying Stocks
When evaluating European dividend-paying stocks, experts say you don’t need to look at them differently than you would a U.S. stock, especially if they are European companies that trade on the U.S. exchange.
Experts say there isn’t a specific blueprint for investing in EU equities, however. “For a company that is more regional, you need to take the economics of those markets into account,” says Marc Lichtenfeld, chief income strategist at The Oxford Club in Baltimore.
A fundamental difference between the two kinds of equities is that many European companies pay out their dividends twice a year, while U.S. dividend-paying stocks pay out every fiscal quarter. This is an important note for fixed-income investors relying on this stream of income.
Investors interested in European companies not listed on U.S. exchanges can still purchase those companies through American depository receipts, or ADRs, which offer U.S. investors this opportunity for foreign exposure.
An ADR is an investment security administered by a broker that represents a share of a foreign company. The security is purchased in U.S. dollars, and dividends are paid out in dollars. For investors who don’t want to deal with added complexities of investing in foreign markets, ADRs offer access to non-U.S. companies in regional markets.
But since an ADR is security from a non-U.S. company, investors must be aware of currency fluctuation risk that may impact dividends.
“Even if a European company’s dividend is flat, for an American investor that number could change depending on exchange rates,” Lichtenfeld says.
To evaluate whether a dividend-paying stock is a good investment, analyze the business and make sure it has a reasonable valuation. Investors who do their fundamental and technical analysis can get an idea of the stability of the company’s financials.
Experts recommend starting by looking at the company’s financial statements.
“For dividend-paying stocks, the best place to start is looking at a company’s balance sheet to see if the company can sustain the dividend,” says Zach Abraham, principal and chief investment officer at Bulwark Capital Management in Tacoma, Washington.
As U.S. corporate debt levels are rising, Abraham recommends looking at the company’s debt obligations. A company’s high dividend can prove unsustainable if debt starts to get unmanageable. “The higher the debt on a company’s balance sheet, the more likely that company is to cut back or suspend that dividend,” he says.
European Market vs. U.S. Market
The U.S. stock market is recognized for its size, liquidity, first-rate regulation and leading companies that attract investors from all over the world.
The U.S. stock market has been rallying higher despite the consequences of the pandemic and being in the beginning stages of a recession.
Abraham says there’s never a period where stock market valuations have been this detached from the underlying economic fundamentals.
“We have record valuations, record corporate debt levels, yet you have valuations in the stock market that suggest to you that everything is humming along,” Abraham says.
European markets have also been hit by the pandemic, however, “they’re far from trading at record high valuations,” Abraham says. “In the U.S., the Nasdaq is up in a year where we’ve sustained the biggest economic shock in our history.”
“Due to the damage the valuation spread has done to the economy, European equity prices are attractive with more upside,” Abraham says.
European assets offer exposure to environmental, social or governance investments — also known as ESG investing, which includes socially responsible and sustainable investing strategies that have positive impacts on society. It’s an investing segment with rising growth opportunities. Companies in Europe have made an effort to focus on sustainability, which has resulted in heavy inflows.
“Europe has been at the forefront of ESG, driving interest and more exposure because many companies inside the EU are leaning toward that area of the market,” says George Mateyo, chief investment officer at Key Private Bank in Cleveland.
Mateyo also points to Europe’s unique geopolitical position, which holds more leverage than the U.S. right now.
Europe has a stable trading relationship with both the U.S. and China and is doing business with them equally, whereas U.S.-China trade and political relations are on thin ice.
“Eurozone is more tied to Chinese trade than the U.S. We’ve seen economic activity in China pick up more than it has in other parts of the world, a tailwind that’s been helping European outperformance,” Mateyo says.
Market Outlook: Long Term vs. Short Term
Given the current global economic conditions, there are opportunities for European equities to outperform U.S. stocks in the short term.
But in the long term, experts express their preference for U.S. equities over euro stocks.
Since many European countries are tied to tourism and leisure, Mateyo says, these countries face challenges in their secular growth and structural headwinds.
“Euro stocks have short-term elements of outperformance, but in the long term, I think the eurozone is somewhat challenged, given the secular differences. Over time, people want to be tilted more toward the U.S.” Mateyo says.
EU stocks are more cyclical, while U.S. equities exhibit secular trends with technology being at the forefront of U.S. equity growth.
“Technology has been on the rise throughout much of the world, but the U.S. continues to have a more dominant position concerning technology, innovation, life science, and I think that will continue to be the case,” Mateyo says.
The euro currency is stable, euro equity valuations appear to be realistic and the eurozone appears to be heading out of the pandemic faster than the U.S.
If you decide to keep, expand or start your exposure to European markets, now may be a stable investment environment for investors looking for income growth.
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