5 Signs of Life From European Markets

In just the past few weeks, the Dutch government folded over failure to adopt austerity measures, an uncertain French election outcome persists, and Spanish bond yields jumped following yet another credit downgrade.

Europe's situation remains a moving target for investors, no doubt. But just before the latest snags, parts of the eurozone, and independent neighbor the U.K., had been stringing together better economic data. Is there hope within the haze?

[See What to Buy as the Dollar Rises.]

Germany chugging ahead. Germany's Ifo business index rose slightly again in April, the ninth consecutive monthly increase. By some accounts, a more troubling reading from the nation's purchasing managers index countered some of the positive reaction. But perhaps investors shouldn't treat all indicators equally. "Ifo has always been more highly regarded than the PMI [and within the PMI report, the services [gauge] held its gain well above [the growth threshold of] fifty. Both are totally ignored," said Canada-based Pinetree Capital's Marshall Auerback in a research note. "The [German DAX stock index] falls almost 4% on the manufacturing PMI. I see the same with the data in other countries. It is as though money managers, and hence the financial press, are getting all worked up about a double-dip even if the economic data overall looks better than it did last autumn."

Slow progress on debt. The heavy debt loads carried by Spain, Greece, Italy, and others will take time to work down, with risks along the way. But one encouraging sign has been positive market reaction (or, at least, relief) when debt auctions run smoothly. In late April, for instance, Italy sold a bond offering that neared its target size, albeit at a higher interest rate than a late-March sale. European stocks rose that day.

United States as life boat? The United States is certainly influenced by Europe's ebbs and flows these days, but Wall Street's performance can still cheer up global investors. The broad-based Europe Stoxx 600 index rose four days in a row in late April. The final boost to this winning streak: An upbeat U.S. consumer sentiment report seen as good news for European exporters. Chinese demand, if it slows down less than expected, could be a big factor, too.

[See Why You Need to Pay Attention to Earnings.]

More central bank action? The European Central Bank hasn't gone so far as to tighten monetary policy, but it is being less accommodative than its counterpart in Washington, writes Morningstar Markets Editor Jeremy Glaser. Does it have wiggle room if things turn for the worse, then?

European Central Bank officials led by President Mario Draghi resisted calls at late-April meetings from the International Monetary Fund and United States Treasury to do more to stem the debt crisis. Euro-area central bankers argued they have done enough by cutting interest rates and issuing more long-term bank loans. Will peer pressure prevail? Some analysts say yes. After all, ECB actions last fall worked rather quickly to shore up the regional financial system.

William Dudley, president of the New York Federal Reserve Bank, said in late March that European liquidity concerns were easing, and funding costs for governments throughout Europe had declined. Dudley didn't entirely rule out more Fed actions if necessary to counter Europe's downturn, but stressed that any such action would be for the United States' benefit.

U.K. independence. Britain snubbed the shared currency and now, although bank linkages make continental problems its problem, too, the U.K. economy has been relatively buffered. U.K. retail sales blew away expectations in March, helped in part by nice weather. But demand for a European investment safe-haven beyond the Scandinavian countries has supported the U.K. financial system, and that support in turn has given consumer sentiment a boost, said Kathleen Brooks, director of U.K. research at currency trading firm Forex.com, in a commentary.

[See How to Protect Your Portfolio With 'Real' Assets.]

Wild card. It's election year in the United States, but perhaps more importantly for portfolios, May elections loom in France, Greece, and Ireland. Change is in the air for at least part of Europe's leadership. The question is whether the winners will embrace further fiscal reform and central bank and IMF debt-fix cooperation, or create a new round of setbacks?

Investment idea. After considering risks, investors likely should maintain some exposure to European equities, which account for some 25 percent of the world's market capitalization. Morningstar's Patricia Oey points out the advantages of the "low cost" Vanguard MSCI Europe Index ETF (VGK). European equities are higher-yielding relative to their U.S. counterparts, and at this time, this ETF has an attractive yield of more than 4 percent. Longer-term, the fund has the mechanics that Morningstar likes, but short-term fundamental headwinds make itsuitable only for those willing to accept a healthy dose of risk.

Something else to keep in mind: Like most international-equity ETFs, VGK does not hedge its foreign-currency exposure. As such, its returns reflect both asset-price changes and swings in exchange rates between the U.S. dollar and European currencies. Looking forward, it is more likely that this foreign-currency exposure will be a drag on the performance of this ETF given the ongoing eurozone sovereign debt crisis, says Oey.



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