Europe's Growth Again Looks Solid

Next to the roaring powerhouses of China and India, European markets look subdued.

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Europe's transportation net offers investors room for growth.

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Next to the roaring powerhouses of China and India, European markets look subdued. But the Old World has quietly posted years of solid gains, thanks to low interest rates, corporate restructuring, and the boom in global economic growth. In 2007, the advanced economies of western Europe outpaced that of the United States, and they're on track to do so again in 2008. And over the past five years, the MSCI Europe index has gained an average of 20 percent per year—and that doesn't even include the fast-growing developing nations of eastern Europe.

Such high-octane returns aren't likely to continue, however. Although European economies are still growing, momentum is fading because of the soaring euro (and sagging dollar) and tightening credit conditions, as the impact of America's subprime mortgage mess continues to spread. The European Union expects economic growth to slow to 2.4 percent over the next two years, down from 2.9 percent in 2007. Still, trends driving Europe's growth should continue. Companies are steadily growing profits, cutting costs, and expanding into perky emerging markets. Mergers and acquisitions chug along, as industries consolidate in countries like Germany, France, and Spain. "The main reason to be optimistic about Europe is the corporate sector," says George Greig, manager of two international funds at William Blair. "But the main reason to question the outlook is the consumer sector." Although unemployment is falling, spending remains subdued in many countries.

Economic reform. Weak consumer spending isn't the only problem. Over the long term, the advanced economies of Europe face major challenges, starting with an aging population and a declining workforce, as birthrates continue to fall. But there is some good news here. "A few offsetting factors to consider include immigration, which will probably be the salvation of Europe," says Paul Sutherland, president and manager of the Utopia funds. "Also, people will probably begin working longer into retirement." Europe is also contending with rigid labor rules that hurt productivity. Many see French President Nicolas Sarkozy's plans for labor reform—which include removing the 35-hour cap on the French workweek—as a hopeful harbinger. The same goes for countries like Ireland and the Netherlands, which have slashed their corporate tax rates to attract foreign investment and promote growth.

Going forward, investors should focus on large, global companies within the consumer and industrial sectors. Firms that specialize in improving transportation, water, and power infrastructure are particularly well positioned to serve both developed and emerging markets. "Plays on infrastructure will work for many, many years," says Ian Hart of the Fidelity Overseas fund. "You've got a lot of pent-up replacement demand, from bridges collapsing to waterways built at the turn of the last century." Rob Quinn, European equity strategist at Standard & Poor's, likes German conglomerate Siemens, which has its hand in everything from power generation to healthcare to construction in emerging markets. He also favors ABB Group, a Switzerland-based engineering firm that's tapping into soaring demand for power in China, India, and the Middle East. Of course, healthcare and travel are also great long-term investing themes, given the demographics of this aging continent.