A 30% Profit Opportunity From Europe's Latest Moves

Adam Fischbaum's picture

Thursday, September 18, 2014 - 12:00pm

by Adam Fischbaum

There’s a classic episode of The Little Rascals where a very tiny Spanky finds a stash of money and proceeds to throw it out of the window to the gang below.

That visualization reminds me of the central banker’s tool known as quantitative easing, often referred to as just QE. This is when a nation’s central bank, in the United States' case the Federal Reserve, contracts the supply of government bonds by buying them from banks, thus keeping interest rates low and, theoretically, giving the banks cash to lend in order to stimulate the economy.

Does it work?  After four years, the U.S. economy has improved slightly. However, the jobs picture is still tenuous and while people feel better, they don’t feel great.

Here’s what happened to the SPDR S&P 500 ETF (AMEX: SPY) when the Fed turned on the spigot.

I’ve never been an advocate of trying to actually time the market. However, some times are better than others for putting money to work. So, even if you “missed” the panic bottom in 2008 and 2009 and didn’t come out of the foxhole for another year, you still doubled your money. You see, the side effect of QE, intended or not, is to make lower risk asset yields so unattractive that investors will go farther out on the risk spectrum for better returns.

So, while the jury is still out on whether U.S. equity markets have run out of gas, a similar situation is setting up in Europe right now.

Two years ago, European Central Bank (ECB) President Mario Draghi stated that he would do “whatever it takes” to avoid the danger of economic collapse in the Eurozone.

As economic activity has slowed across the European Union -- even in Germany,  the Union's largest economy -- and talk of deflation has appeared, Draghi has exercised that “whatever it takes” option.

Recently, the ECB cut its main interest to 0.05% from 0.15%; effectively zero. The central bank also announced that it will begin buying asset-backed bonds and securities from Eurozone banks, liquefying the system and in turn giving the banks the encouragement to lend the money. QE has come to Europe.

What opportunities does that create for investors? Well, the most obvious would be in a broad-based European equity exchange traded fund. The SPDR Euro Stoxx 50 Index ETF (AMEX: FEZ) seems like a logical choice.

Looking at the chart, it seems that European stocks have rebounded nicely since the sovereign debt crisis of 2011, brought on by the economic collapse of Europe’s southern periphery. But there’s still room to move.

The effect of Euro QE suppressing rates is already taking hold. The benchmark German 10-Year Bund is barely yielding 1%, the five-year rate is less than 25 basis points (bps) and the two-year is in negative territory. Just like in the United States, investors will have to look for Euro-area assets that will pay them more. Stocks, anyone?

In addition to FEZ, some larger European bank stocks may be worth a look. Financial stocks always benefit from accommodative monetary policy. One of the more interesting names is French giant Credit Agricole S. A. (OTC BB: CRARY). I profiled this stock in July, and I still consider it an actionable opportunity.

What about U.S. rates?
While market pundits speculate on when the rally in U.S. treasury bonds will come to a screeching halt, it may not be a bad idea to postpone the funeral plans.

Global investors are looking for a low-risk investment and a decent yield. With German bond yields virtually non-existent, the U.S. 10-year treasury, which yields between 2.4% and 2.6%, looks mighty attractive. And even as the Fed tapers its bond purchasing program, expect safe-money interest to keep the supply tight for the time being.

The result: expect U.S. interest rates to stay low in the near term and maybe even the medium term. Stocks still look pretty good.

Risks to consider: The biggest risk to keep in mind when making a broad-based trade linked to European monetary conditions is the strange nature of the EU itself. Remember, that unlike the United States, which is a true political union, Europe is a monetary union without a central government. The risk of one nation deciding to pull out of the Euro, while higher or lower at times, is always present. Another risk is that while Draghi has moved to an accommodative policy, Germany, who as the strongest economy in the EU, tends to influence behavior the most, typically tilts towards austerity, which will always hamper economic growth.

Action to take --> With the easy money policies continuing to ramp up in the European Union, FEZ is teed up for impressive returns. If European markets react similarly to American markets, then FEZ could move 30% in 12-to-18 months. Trading near $41 with an attractive 3.1% dividend yield, FEZ shares could hit $53 near term. Longer term, 3-to-4 years, a double to $82 isn’t out of the question if FEZ behaves like its American cousin.

If you are looking to Europe, FEZ is one of the best bets, but there are equally as lucrative international investments hidden across the globe. In fact, 79% of the world's highest-yielding stocks are overseas and our premium newsletter, High-Yield International, specializes in finding the cream of the crop. For more information on some of the 93 stocks offering yields of 12% or higher, click here.

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.