Don't Rush to Buy Europe's "Bargains"

Dan Caplinger The Motley Fool May 19, 2010

By Dan Caplinger May 18, 2010 | Comments (0)

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With everyone looking at Europe through a veil of fear and uncertainty, you might think that you need to rush to buy bargain European stocks on the cheap before the big sale ends. But buying stocks isn't like shopping for Christmas presents on Black Friday. Often, those who wait get the best bargains of all.

Ugly and uglierThe turmoil in Greece has turned all eyes toward the Euro zone, as fears have risen that sovereign debt defaults could cause a huge ripple effect throughout the world's banking system and the global economy as a whole. After weeks of maneuvering and stalling, the European Union and the International Monetary Fund announced a $1 trillion rescue package early last week, similar in scope and purpose to the TARP bailout that the U.S. implemented two years ago in response to its own financial crisis.

As happened here two years ago, European stocks got a brief shot in the arm from the news. Markets in Britain, France, and Germany all reversed some of the steep losses they'd suffered, and the euro halted its freefall against the U.S. dollar -- temporarily.

Some think that means opportunity. But buying now could be jumping the gun.

Looking longer-termThe problem is that in crafting a short-term solution, Europe left itself exposed to the same troubles that plagued the U.S. two years ago. The huge budget deficits that resulted from government spending here prompted a flight away from the U.S. dollar to the euro and other currencies, which at the time were perceived as being more stable.

Now, Europe is in the same boat. Even though the European Central Bank is generally perceived as being more hawkish in preventing inflation than its Federal Reserve counterparts in the U.S., the ECB can't really afford to raise rates without endangering the effectiveness of the rescue package.

The region is also going through political upheaval. The election in Britain earlier this month resulted in a fragile coalition government that has further diminished confidence in the British pound. The ruling party in Germany suffered a defeat in local elections that brings into question whether current Chancellor Angela Merkel will survive the fallout from the unpopular EU bailout.

Meanwhile, the U.S. economic recovery seems to be continuing. Improvement in job growth and greater import demand could further revive once-struggling consumers. Resulting inflation pressure would typically lead the Fed to raise interest rates, making the U.S. dollar even more attractive.

Don't cut your winnersWhat this means for investors is that looking for bargains in pound- or euro-denominated assets is probably premature. In the U.S., it took months for markets to become convinced that the financial system wasn't falling apart -- and patient investors who waited it out throughout 2008 got cheaper entry points for their stock purchases in early 2009.

Among direct currency plays, buying CurrencyShares Euro Trust (NYSE: FXE) or CurrencyShares British Pound Sterling Trust (NYSE: FXB) would leave you exposed to further losses if the dollar keeps strengthening against the two currencies. In contrast, buying shares of PowerShares US Dollar Bullish (NYSE: UUP), which uses futures in the euro-dominated US Dollar Index, will likely give you profits if the euro keeps declining.

On the stock side, remember that a rising dollar will actually help some European companies. GlaxoSmithKline (NYSE: GSK) got 36% of its 2009 revenue from the U.S., while German software giant SAP's (NYSE: SAP) U.S. market makes up about a quarter of its revenue. As it will take three to six months for a stronger dollar to filter its way through to financial reports, you can likely afford to wait for better exchange rates before investing.

In contrast, a stronger dollar may eventually cause trouble for U.S. companies that do significant business in Europe. The last time the dollar was strong, McDonald's (NYSE: MCD) and Mattel (NYSE: MAT) both argued that it hampered their profitability.

Race to the bottomThose who are bearish on the U.S. dollar's prospects have reason for their pessimism. But as bad as fundamentals may look for the dollar, they're even worse for the euro and pound. That means that the dollar may get a respite here, at least for now.

Scared of investing internationally? Let Matt Hoffman show you how not to get mugged in the world's financial markets.

Fool contributor Dan Caplinger signaled the dollar's imminent rise when he decided not to trade in his New Zealand currency when he got back from his last vacation. He doesn't own shares of the companies mentioned in this article. The Fool owns shares of GlaxoSmithKline. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy speaks the international language of money.

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Don't Rush to Buy Europe's "Bargains"

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