European stocks posted good gains in the second quarter, registering a fourth successive quarter of positive returns. Market sentiment was buoyed by expectations for further quantitative easing by the European Central Bank to support a nascent economic recovery and avert deflation. However, shares trailed broader developed and emerging markets indices amid ongoing concerns about low inflation, lackluster growth, and stagnant corporate earnings. Stocks in defensive, higher-yielding sectors such as utilities, health care, and energy performed best and outpaced the more cyclical financial, industrial, and information technology sectors. The UK led with the strongest gains, along with Norway and Spain. Ireland, Portugal, and Sweden were relatively weak.
The European Stock Fund returned 0.05% in the quarter compared with 3.65% for the MSCI Europe Index and 1.46% for the Lipper European Region Funds Average. For the 12 months ended June 30, 2014, the fund returned 29.29% versus 29.95% for the MSCI Europe Index and 26.74% for the Lipper European Region Funds Average. The fund's average annual total returns were 29.29%, 15.91%, and 9.35% for the 1-, 5-, and 10-year periods, respectively, as of June 30, 2014. The fund's expense ratio was 0.96% as of its fiscal year ended October 31, 2013.
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The European Stock Fund charges a 2%
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The performance information shown does not reflect the deduction of the redemption fee;
if it did, the performance would be lower.
Consumer discretionary remains our largest sector overweight, and we increased our exposure further during the quarter. We remain upbeat about European broadcasters. We are seeing signs of stabilization in television advertising trends, and as the market continues to gradually return to growth, we believe this will be accompanied by appreciable operating leverage as these companies have tightly reined in costs. Consumer staples represents our largest sector underweight. While the sector generally offers good earnings growth visibility, strong returns, and healthy dividends, we believe it continues to look unattractive due to expensive valuations, both relative to the market and in absolute terms.
Following steady improvement since the middle of 2012, European economic data in general have deteriorated of late. On a country basis, however, some economic indicators remain expansive, and we expect the shallow recovery to continue. Consumers appear to be regaining some confidence, and credit availability has started to improve. Inflation remains below target, but we believe the European Central Bank has shown itself ready and able to stimulate growth. Stagnant corporate earnings should improve as the economy returns to growth, and valuations remain attractive. We continue to find opportunities in domestically oriented businesses that have been overlooked by the market and global franchises that have lost value amid recent emerging market growth concerns.