Over the past couple of weeks, we have executed several portfolio transactions in line with our belief that the second half of the year may be a good one for stock investors. Most of the trades have been relative in nature; for example, we’ve swapped defensive U.S. sector holdings for late cyclical sectors. We also traded “up” within our international holdings, by swapping a fairly conservative actively managed fund for an ETF targeting mainland Europe (the iShares MSCI EMU Index Fund; symbol EZU). In our two most aggressive policies, we purchased the iShares MSCI Italy Index Fund (symbol EWI).
That may be surprising, considering that Europe continues to struggle with both an ongoing debt crisis and a deepening economic slowdown. However, equity markets in Europe have taken a beating, with countries like Italy and Spain both recently falling to levels that are off by more than -60% from their 2007 highs. Combined with the large degree of pessimism that investors have towards Europe, we think that any news that ends up being better than the worst case expectations that permeate the headlines would likely be enough to spark a rally in European stocks. In fact, we may be seeing the beginnings of that already. From the June 1st low in the S&P 500, EZU is up nearly 18%, well ahead of the S&P’s 11% gain (see the chart on the right).
We’re under no illusions that Europe is out of the woods. Over the course of the past two years (and counting), there have been a string of disappointments in European leaders’ inability to deal decisively with the serious fiscal problems they face. Instead, we view this move as dipping a toe in the water in an area that has gotten pounded,
and thus, where long-term value is beginning to build. There is likely to be more volatility out of Europe in the weeks ahead as their leaders continue to haggle over the details of a solution. In the event that European markets take another dive, it may serve as an opportunity to add to these positions with an eye towards the longer-term potential that we believe is being created there.