2 European Gems with Rock-Solid Yields

07/21/2011 7:30 am EST

Focus: GLOBAL

Paul Tracy

Editor, The StreetAuthority Market Advisor

As Europe continues sorting out the PIIGS, many stocks are doing well in the Old World and are priced attractively, notes Paul Tracy of High-Yield International.

Market volatility is back with a vengeance.

 In early July, the difference between the interest rate that Italy pays on its bonds and the rate that Germany pays on its bonds reached the highest level since the euro was introduced in 2002. That’s a sign that investors are beginning to worry that Rome will need support from the EU

Investors remain concerned about Italy’s debt, which is expected to reach 120% of its GDP this year, or about 1.8 trillion euros ($2.5 trillion). But Italy’s fiscal condition is not the same as its smaller European peers.

The country’s budget deficit was about 4.6% of GDP last year, compared with close to 11% for Greece, 9.2% for Spain, and more than 30% for Ireland. Also, unlike Greece and other smaller countries, Italy’s economy has not fallen back into recession, despite a series of austerity measures passed over the past few years.

Continued economic growth in Italy, albeit at just 1% or so annualized, helps reduce public opposition to further budget-cutting measures. In addition, growth helps buoy tax revenues and makes it easier to bring down debt and balance the budget.

The Italian Cabinet has passed a tough, 40 billion-euro ($55 billion) additional austerity plan that’s designed to bring the budget into balance by 2014. The government of Prime Minister Silvio Berlusconi holds a slim majority in Parliament, and will likely be able to pass the package into law by early August, a move that would help calm markets.

While the EU may be willing to allow a small economy like Greece or Ireland to enter selective default on its debt, leaders are keen to ensure stability in Spain and Italy. These countries are the fourth and third largest in the EU, respectively. Against this backdrop, the concern surrounding Italy and Italian shares look overdone.

EU credit troubles aren’t the market’s only concern. The promising grand bargain between President Obama and Speaker Boehner to avert a technical US default still looks to be on shaky ground. While some form of compromise continues to be the most likely outcome, the US will hit its debt ceiling on August 2.

That looming deadline remains a concern for global markets. If fears of a US default send interest rates sharply higher, the fallout for the global economy would be severe.

While some economic data have improved in recent weeks, the June US employment report showed just 18,000 jobs created in the month, well under expectations of around 100,000. That dismal release was a grim reminder that the US economic recovery remains faltering.

The market’s worst fears are unlikely to come to fruition. But while the headlines focus on macroeconomic forces, individual stocks will continue to be buffeted by broad market sentiment rather than stock-specific fundamentals. That presents an opportunity for savvy investors.

In some cases, investors are throwing out the baby with the bathwater. European stocks, particularly those based in Italy and Spain, have been hit by fears of sovereign credit turmoil regardless of their fundamentals.

That’s offering investors an opportunity to pick up shares of stocks like Eni (E) at a discount. While Eni is based in Italy, its operations are global, and the company is leveraged to the prices of oil and European natural gas, both of which have been strong this year.

Even France-based Sanofi (SNY), a stock in the defensive healthcare sector, has been hit by broader market selling despite favorable clinical trial results on new drug candidates.

It’s important to keep your eye on the big picture—long-term trends for the economy and corporate profits drive the stock market.

But it’s equally important to keep tabs on individual stocks, and to look for an instance where the market, preoccupied by macroeconomic events, isn’t giving companies enough credit for their growth and earnings prospects.

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