The Russians are coming, the Russians are coming! Literally.
And that means it’s time for us to take some profits off the table.
You’ll recall, in June 2013, I told you to hold your nose, flex your contrarian muscles and buy beaten-down European banks. Specifically, the iShares MSCI Europe Financials ETF (EUFN).
The bargains were just too darn irresistible.[ad#Google Adsense 336×280-IA]At the time, European banks were trading hands at a price-to-book (P/B) ratio of just 0.78.
That was a staggering 58% discount to the long-term average, based on the STOXX Europe 600 Banks Index.
If you followed my original advice, congratulations!
Buying low paid off, since you’re now sitting on a respectable unrealized gain of 20%.
Today, however, I recommend that you realize it.
It’s not because I think European banks are suddenly overpriced, or even fairly valued. On the contrary, they still trade at about a 40% discount to the long-term average P/B ratio.
Instead, I’m recommending that you cash in your winnings because of, well… the Russians. No joke.
Here’s a rundown on the specific reasons why…
Don’t Be Blinded By the Bargains
Everyone is salivating over the “mouth-watering” valuations in Russia, as the analysts at Credit Suisse (CS) put it.
While they’re trying to figure out when to pounce on the bargains, however, we need to be concerned about the impact of a prolonged conflict.
Because that’s exactly what could be in store.
And when it comes to European banks, the impact could be significant.
As you can see in the chart, European banks are heavily exposed to Russia. Much more so than U.S. banks. All told, we’re talking about $156-billion worth of assets tied to Russia.
Italy’s UniCredit appears to be the most at risk, with almost $25 billion in assets in its Russian subsidiary.
Granted, the Russian exposure is spread out over large asset bases at these banks, thereby mitigating the risk.
Plus, the iShares MSCI Europe Financials ETF invests in 102 different companies – with no single position representing more than 10% of the portfolio.
So our risks are mitigated even more. Nevertheless, we can’t ignore them. They’re real and material.
In fact, a sensitivity analysis by Morgan Stanley (MS) suggests that earnings at European banks could drop by as much as 13%, in some cases.
Since stock prices ultimately follow earnings, that doesn’t bode well for the short-term performance of the fund.
More Downside Risks Than Upside Potential
It’s never what we can see and quantify that undermines our investments. It’s what we can’t fully anticipate or calculate that does so.
Or, as The Economist’s Intelligence Unit says, “The exact impacts on [European] banks are difficult to judge in advance.”
Not only would ongoing sanctions against Russia restrict European banks’ operations in the country, they could hamper economic growth in the European Union as a whole. Exports to Russia account for 0.6% of European GDP growth, which is a big amount when the European Union is struggling to grow at all.
Moreover, Europe relies heavily on Russia for oil and gas. For example, 40% of Germany’s gas and 50% of Austria’s gas comes from Russia. Any disruption in supplies promises to drive up prices, thereby pressuring the entire European economy.
We can’t overlook the impact of rapid currency devaluation in Russia and Ukraine, either. It would reduce the value of banks’ assets, as well as increase the risk of defaults.
Add it all up, and the current risks outweigh the potential rewards. The best thing to do, then, is to take our money and run. So don’t delay.
Take your profits in the iShares MSCI Europe Financials ETF before they turn into losses.
Rest assured, I’ll be in touch before long with a compelling new opportunity to reinvest the proceeds.
Ahead of the tape,
Source: Wall Street Daily