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Brave hearted tempted to invest in Europe's high anxiety

00:00 EDT Monday, June 11, 2012

savery@globeandmail.com

One week from now, stock markets will pass judgment on Greece's second attempt to elect a new government.

The results of the June 17 election will clarify whether the country stands a chance of staying in the euro zone, or whether it will default on its debt and be forced out of the world's most ambitious currency club.

One way or the other, the growing level of tension in the euro zone holds potential for Canadian investors, because European bourses already trade at a deep discount to North American markets - a gap that could grow wider if the election ratchets up euro anxiety.

The average price-to-earnings (PE) multiple on London's FTSE 100 index and Paris' CAC 40 index now stands at a fraction above 10. That's far below the 13 PE that is typical on New York's S&P 500 index and Toronto's S&P/TSX index.

Meanwhile, European dividend yields exceed 4 per cent, about double the 2-per-cent level on the S&P 500.

A win in the June 17 election by Antonis Samaras' conservative New Democracy party would likely ensure that aid continues to flow to Greece in return for radical austerity measures. This outcome would disturb markets less than the alternative, but it would be less definitive. It would allow Greece and the rest of the European Union to muddle along without being forced to enact structural changes.

On the other hand, a victory by political parties opposed to the bailout, led by the leftist Syriza party, would likely see the new government tear up the agreement behind the bailout from the European Union and the International Monetary Fund, in hope of negotiating softer terms. But European officials warn that if Greece fails to honour its agreement, funding would be cut off and the country would default on its debt and be forced out of the euro zone.

An unruly Greek exit could freeze global credit markets. The European investment bank, Société Générale SA, has warned that European stocks could plunge 50 per cent in this scenario.

For the brave hearted, this sounds like an excellent opportunity to pick up bargains. However, there are caveats: While European stocks are trading at their lowest level in 15 years, they're saddled with two big risks, says Danielle Park, president and portfolio manager with Venable Park Investment Counsel Inc.

First, Europe is leading the globe back into recession and many earnings forecasts are not realistic in this environment. Second, there is too much potential downside to the euro.

A forcible exit of Greece from the euro zone would be a "shock event" that could devalue the currency and remove a lot of the risk tied to owning European stocks, Ms. Park contends. She has kept her clients mostly in bonds and cash through the recent financial turmoil, but she says European stocks could begin to offer a good buying opportunity at much lower risk this summer.

Ms. Park would prefer to buy a basket of European stocks through an exchange-traded fund or other vehicle, rather than individual stocks, which she says carry greater risk. That said, it's hard not to be tempted by a few European companies.

The pharmaceutical giant AstraZeneca PLC trades at a PE multiple of only 6.3, compared with 14.7 for the industry. The bad news is that the drug maker's revenue dropped 11 per cent last quarter, its profit plunged 44 per cent and its chief executive officer stepped down. But patient investors might be willing to wait for a rebound as they collect a dividend yield of almost 10 per cent.

France's Total SA is trading near its low for the last decade, carrying a PE multiple of just 6.6 next to a dividend yield of 6.1 per cent. The oil and gas company has lucrative projects in Russia and is ramping up production in Nigeria, Norway and Angola. (In comparison, the much smaller Suncor sells at 10.7 times earnings and pays a dividend of only 1.7 per cent.)

Both AstraZeneca and Total shares trade through American depositary receipts on the NYSE.

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