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How to Bet on Europe’s Recession

Europe expects to be in a recession this year, and the continent’s Central Bank isn’t budging on the need for severe austerity measures for the worst-hit countries. But some advisers and fund managers see opportunity in this continuing gloom.

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The European Commission released fresh economic projections on Thursday that showed the euro-zone’s economy contracting in 2012, a sign that conditions have worsened since November, when the region was expected to show slight growth for the full year. Also Thursday, the president of the European Central Bank said countries like Greece should stick to their strict deficit targets, recession or no recession.  The EU now projects Greece’s economy will shrink by 4.4% this year, worse than the 2.8% contraction projected in November, and Italy and Spain are now projected to see contractions for the year. Like the euro-zone itself, they had previously been expected to grow slightly.

Despite the stormy forecast, some value investors are snapping up European stocks, noting that the slowdown is already priced into shares. “The investment opportunity is now, not later,” says Jamie Cox, a managing partner at Harris Financial Group. Investors should focus on financials and consumer cyclical stocks, which have been particularly out of favor, he says. Cox says he’s been adding some dividend-paying cyclical stocks, including industrials, in client portfolios, taking the average stock portfolio’s European portion from about 16% last summer to roughly 20% today. But it’s best to select individual stocks, or find an active manager who will hunt for undervalued gems, he says, because “in a recession, the best companies shine.”

Of course, investing in the region still comes with plenty of risk. The recession could end up being deeper or lasting longer than current projections suggest. If high oil prices persist, for example, that could further crimp consumer spending in the region and around the world, making Europe’s downturn far worse, Cox notes.

Nevertheless, some high-profile fund managers are currently overweight European stocks, according to a new Morningstar analysis. The bargain-hunters include well-regarded funds like the Tweedy, Browne Global Value fund (TBGVX), the Oakmark International fund (OAKIX) and the Causeway International Value fund (CIVVX).

Not only is Europe a good place to look, beaten-down stocks from the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) appear poised to outperform this year, says Michael Gayed, the chief investment strategist at Pension Partners. Central banks around the world are pumping money into their markets and attempting to jump-start inflation — and heavily indebted companies and nations tend to outperform in inflationary periods; as the value of money drops, it costs less to pay down debt, Gayed explains.

But there are already some signs that a rebound is beginning, Gayed says: Small-cap stocks are starting to outperform large-cap stocks, a sign of a more bullish environment, and the performance of the PIIGS’ stock markets is improving relative to the S&P 500. “The skepticism is still there, but that’s exactly how bull markets are born,” he says. “If everyone believes in it, then presumably everyone has already invested in it.”

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