With several countries in Europe on the verge of default—most notably Greece, which has been downgraded twice by Moody's Investors Service in less than a month—the continent may seem like a bad bet for investors, at first glance. But outside Portugal, Ireland, Italy, Greece, and Spain, countries often referred to as the PIIGS, there may be some bright spots for investors.
U.S. News recently spoke with Nichola Noriega, international equity strategist at Pittsburgh-based Federated Investors, about which areas of Europe currently offer the best investing opportunities. Excerpts:
What is the current outlook for investing in Europe?
We've been talking about the theme of divergence for probably a couple of years now. Clearly, there has been a lot of divergence between the developed markets and the emerging markets. But we've also been talking about the divergence within Europe, between the economies that we think are more global-facing with large export bases and then the economies that we felt were going to be mired in the high-debt, high-deficit issue for a while. This is something that we've been thinking about for quite some time. We've been focused on countries like Norway, Denmark, and Germany, countries that we think have high sovereign quality, both on an absolute and relative basis.
What do you mean by high-sovereign quality?
We look at a combination of things. We look at public debt-to-GDP. We look at budget balances and GDP. We also look at current account balances, trying to figure out essentially, is there cash coming in or cash coming out? How are exports growing? We also look at foreign currency reserves as a percentage of GDP. We look at all of these things together to look at the sovereign health of the economy. Those things have led us away from most of the peripheral economies.
Do you think the PIIGS designation is accurate?
Yes and no. Clearly, there are some similarities between them, but we see some distinctions amongst them as well. Clearly, Greece, Portugal, and Ireland are in a very troubled place right now. Greece and Portugal have very little exposure to the global economy, so they're very reliant on what's going on within their economies. It's a more difficult position to dig yourself out of.
We see Italy as being very different. Certainly, debt is high there, but they own most of their debt, so they're not as susceptible to [bond] spreads widening like in Greece, Portugal, or Ireland. So they're in a very different position, in that they can fund themselves a lot more easily than some of these other economies, and therefore, it has less of an impact on their economy. When you look at the widening of [bond] spreads ... for countries like Spain and Italy, they've stayed pretty reasonable, even during the latest leg of the crisis where Greek spreads are widening significantly. Portuguese spreads are widening, and Irish spreads are rising. The market is starting to see some distinction between these economies, so we wouldn't lump them all together.
What's next for Greece?
We tend to think there is going to be some sort of a [debt] haircut coming. [There is] the Vienna plan. That may well be it. It may well be that they encourage the banks to roll over this debt and kick the can down the road a bit here. Clearly, the [European Central Bank] and the [European Union], for the matter, are very much against an official haircut, so we may well see a solution where some of these banks are going to be asked to roll over the debt over the medium term. I think that would be the least painful way for them to go. Again, it's such a fluid situation, but that might be the most appetizing for the market.
What about the bright spots in Europe, such as Denmark and Norway?
They're both relatively small markets. Everybody focuses on core Europe—Germany, France, and Spain—and I think the Scandinavian economies have not gotten as much air time. ... They have a much lower correlation to the United States, so you get even more bang for your buck by being in them. We think they definitely are the bright spots for a variety of reasons. One, certainly, [is their] sovereign quality. The reason we think sovereign quality is important because it sets the environment for corporations to operate in.