BlackRock’s Koesterich: Europe’s Banks Are Its ‘Achilles’ Heel’

At Commonwealth gathering, investment guru sees danger, opportunity in Europe; suggests ‘great rotation’ to equities ‘is not happening’

Russ Koesterich, chief investment strategist for BlackRock, told the advisor attendees at Commonwealth Financial Network’s Chairman’s Retreat on Monday that while he sees some investing opportunities in Europe, he also believes the European banking sector is the “Achilles’ heel of Europe."

Russ KoesterichSpeaking just after plans were announced for a European Central Bank bailout of Cyprus, Koesterich (left), who is also chief global investment strategist for iShares, drew a contrast between U.S. and European banks. While the U.S. financial sector has mostly delevered and the U.S. economy is “on a sounder footing than I expected," he argued in a response to a question from Commonwealth chief investment officer and fellow CFA Brad McMillan that “Europe never fixed its banks.” That Achilles heel can be pricked if depositors start withdrawing from Greek, Italian and Spanish banks, he said.

However, Koesterich suggested that there were areas of Europe that provide opportunities for investors, notably in Norway and Sweden. And while valuations among U.S. companies have increased to the point that many are trading at a premium to their book value, especially smaller-cap stocks, the “valuation cushion” might be stronger internationally, especially in smaller developed countries like Singapore and Switzerland.

Returning to domestic matters, in answer to an advisor’s query on whether the markets are currently experiencing a “great rotation” back into equities, Koesterich was dubious. “It’s not happening,” he said, arguing that fund flows into equities are not coming from bonds, but rather that investors are moving out of cash accounts back into equities, using proceeds from sales of appreciated equities last year.

As for U.S. economic growth, Koesterich said that while debt as a percentage of GDP has stabilized, “total nonfinancial U.S. debt” stands at 251% of GDP. “When debt gets this high," Koesterich warned, "it has an effect on growth.”

McMillan began the session, which took place during the 10th annual Chairman’s Retreat for top-producing Commonwealth Financial reps, by asking if Washington was still the “financial capital of the world.”

Koesterich’s response: “We’ve spent too much time worrying about Washington,” and that at least in the short term, “we’ve dodged most of the issues” around government debt. Longer term, he said that “the U.S. can go on like this for another four to five years,” spurred by quantitative easing and slow though stolid economic growth, and that the deficit “won’t start looking bad until 2017.” By then, he warned, the increasing numbers of retiring baby boomers may contribute to a “crowding-out factor,” when the government’s need for financing may bump up against consumers’ borrowing needs.

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