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While the U.S. economy has an unemployment rate below 5%, growth in gross domestic product and a rebounding housing market, the economy in Europe remains in deep trouble. Rampant unemployment, social unrest and weak economic growth remain the norms in the eurozone.
In response, the European Central Bank has kept its foot on the monetary gas pedal. The ECB has thrown everything at the problem within its power. At its March 10 meeting, the ECB decided once again to pursue aggressive monetary easing.
Although these actions initially were met with praise, the market retraced much of the gains, as the harsh reality set in. Economic conditions are still poor in Europe—but that doesn’t mean investors should avoid the region altogether.
Here’s why investors should view European equities positively in the wake of the ECB stimulus, even while the eurozone crumbles.
Super Mario Leaps to Action
ECB President Mario Draghi announced a wave of new stimulus measures, designed to resuscitate the European economy. These actions will include lower interest rates, more bond purchases and even a potential subsidy for lenders.
First, the ECB reduced the interest rate on overnight lending by 10 basis points, to minus 0.4%. A negative rate essentially means banks are punished for parking cash with the central bank. The ECB also lowered its benchmark rate for bank-to-bank lending at zero.
In addition, the ECB announced it will increase its bond-buying authorization to 80 billion euros (approximately $87 billion) from 60 billion euros. And, now corporate bonds will be eligible for purchase by the ECB.
These measures are expected to be in place for some time, perhaps another several years. Along with the announcements, the ECB stated it would leave interest rates at these levels, for a long period of time — even after its asset purchase program ends.
Little Help to European Stocks
After an initial pop in the aftermath of the announcement, European stocks quickly traded lower, after investors came to the cruel realization that the economy in Europe simply isn’t doing well. European stock prices moved inversely to its currency, which traded higher.
Another factor pouring cold water on the bulls is that Draghi mentioned it likely won’t be necessary to lower rates further. Investors seemed to take this as a signal of potential monetary tightening down the road, which would be a negative for European stocks and bonds.
However, this would be a false reading. In no way, shape or form, will the ECB tighten its policy until the Europe’s economy justifies such measures. Draghi has repeatedly stated his full intention to do whatever is necessary to revive inflation, GDP growth and higher levels of employment.
Importantly, the ECB slashed its projection for inflation in the eurozone this year. The ECB now forecasts just 0.1% inflation in 2016, down from prior forecasts for 1% inflation. This means inflation is now expected to be barely positive — dangerously close to deflation, which the ECB wants to avoid at all costs.
As a result, it’s clear that the ECB won’t do anything to jeopardize the fragile state of the European economy. Continued low interest rates and quantitative easing will be positive for European equities. Specifically, investors should focus on highly profitable European companies that have significant operations outside Europe, and pay hefty dividends.
European Dividend Stocks Look Attractive
Two stocks in particular that look attractive are consumer goods giants Unilever PLC (NYSE: UL) and Nestle SA (OTC: NSRGY).
Unilever’s total sales rose 10% last year, thanks to 7% revenue growth in the emerging markets. Earnings per share grew 14% year-over-year.
Similarly, Nestle grew organic sales, which exclude the effects of foreign exchange fluctuations, by 4% last year. Its underlying earnings per share rose 6%, and Nestle increased its dividend.
At their current stock prices, Unilever and Nestle offer solid 3% dividend yields.
Even better, despite being based in Europe, these two companies aren’t overly exposed to the European economy. Nestle generates slightly less than half of its total revenue from emerging markets, while Unilever derives nearly two-thirds of its sales from emerging markets.
The bottom line is that while the ECB may not reduce rates further, it’s nonetheless going to continue pumping as much money into the European economy as it possibly can. This should be a tailwind for profitable European companies with high dividends, like Unilever and Nestle.
How to Sleep Easy at Night
Is the economy keeping you up at night? Do you worry there’s another crash just around the corner? If so, you can stop worrying right now. All it takes is a few minutes.