This guest post was written by my former editor at Worth and old friend, Jim Jubak, one of the best financial writers in the nation.
It sure has been fun—in a crash on the Interstate kind of way—to rubberneck as Greece threatened to leave the EuroZone/default on its debt/suffer through a meltdown of its banking system. But now that the crisis is over—until June anyway—it’s time to get back to the much less dramatic but much more powerful story that’s going to drive investment returns in and around the EuroZone for the rest of 2015 and into next year.
Yep, it’s time to focus on the European Central Bank again and its plan to buy 60 billion euros of government debt, asset-backed securities, and covered bonds—every month starting in March and stretching until September 2016 or until there are signs of inflation picking up.
The bank is scheduled to reveal more details of its plan on Thursday, March 5. But we can already see money managers and traders—especially in the bond market—positioning for the central bank’s move.
Oh, we’re not really done with Greece and its problems. The recent deal to give Greece an extra 7.2 billion euros and four months to “fix” its economy and banking system is another example of the EuroZone’s favorite strategy of extend and pretend. Greece can’t pay back its debt under current terms and the country’s creditors won’t even entertain the possibility of cutting Greece’s debt. Their solution? Putting enough austerity measures in place so that Greece generates a big enough budget surplus to repay its debt. Ain’t gonna happen. And that should be obvious by June.
Just this Monday, March 2, Spain set off a storm among EuroZone countries by saying out loud what everyone has been thinking: Greece will need a third bailout—with a cost of somewhere around 50 billion euros—early this summer.
(And, of course, there is the minor issue of whether Greece will commit to enough “reforms” in detail so that the International Monetary Fund, for one, will actually agree to release those 7.2 billion euros.)
But Greece for much of the world is a sideshow. The Greek economy isn’t big enough to move financial markets--especially now that it looks like a Greek meltdown won’t take Spain or Italy or Portugal with it. The Greek banking system isn’t systemically important to the world financial network—especially now that most Greek government debt is owned by EuroZone national banks. And EuroZone institutions are indeed better prepared for a Greek exit/meltdown than they were two years ago.
The Greek exit—not from the euro but from EuroZone headlines--leaves the EuroZone and global investors free to focus on the ability of the EuroZone as a whole to solve its intertwined problems of very slow growth and inflation so low that it threatens to tip into deflation. Hopes here, once again, rest with Mario Draghi and the European Central Bank. The bank’s plan is buy enough bonds—mostly this time government bonds--to drive interest rates, already at historic lows, even lower. And to send the euro, already reeling against the U.S. dollar, down even further. The theory is that these moves in combination will lead to more growth—mostly from making euro-denominated exports even cheaper on world markets—and higher inflation—by making imports denominated in dollars, yen, and whatever—more expensive.
There are good reasons to be skeptical about the success of this program. The EuroZone’s experience with low rates suggests that the problem isn’t expensive money but the unwillingness of banks to lend. Even the European Central Bank’s drastic resort to charging banks to keep reserves at the central bank doesn’t seem to have jump-started lending. One of the reasons that the strongest credits in the EuroZone now show negative yields is that banks seem willing to pay to keep cash safe and liquid—they would just like to find a way to pay slightly less for the privilege than the 0.2% that the central bank charges to keep bank reserves on deposit. Buy a German 5-year note and the yield is just a negative 0.06%. Quite a bargain, no?
But the real reason to be skeptical is the central bank’s plan amounts to a kind of trickle down monetary economics for the EuroZone as a whole. A cheaper euro is indeed likely to have a positive impact on EuroZone exports. (Assuming that competing currency devaluations from Japan and China don’t wipe out the advantage.) But individual EuroZone economies are by no means uniform in their export exposure or prowess.
For example, exports accounted for 46% of GDP in Germany in 2013, according to the World Bank. Denmark at 54%, Poland at 46%, and Sweden at 44% are similar export powerhouses among European economies. (You do need to take these figures with a grain of salt at the extremes. It does seem unlikely that exports make up 203% of GDP for Luxembourg. But in general the percentages seem to fall in the correct ballpark. Exports accounted for 72% of GDP for Switzerland but just 14% of GDP for the United States with its historical emphasis on a huge domestic market. The figure for the Netherlands at 83% seems a likely overstatement although there is no doubt that the Dutch economy falls in the export-heavy group.)
On the other hand, look at the percentages for Italy (29%), Spain (32%), Greece (30%), France (28%), and the United Kingdom (30%). These lower figures reflect economic structures and traditions that don’t change overnight and the relative competitive advantage of national exports from these countries. One of the real problems that a country such as Greece faces in digging out of its horrendous level of indebtedness is that the country has relatively few globally competitive export industries. A falling euro won’t increase Greek export competitiveness versa Germany or Poland or Italy. The short-term solution is to increase Greek competitiveness by cutting Greek wages—and that’s not exactly a model for fast economic growth.
Whatever the theory may be, an economic recovery built on a cheaper euro and rising exports—if it is to work for Europe as a whole—would have to begin with export-led growth in the export-led, globally competitive economies of the region and then expand as growth in those economies turned into consumption by domestic workers of goods and services from other European economies.
Right now global financial markets aren’t expressing much of any skepticism about the effectiveness of the European Central Bank’s program of asset purchases. So far in 2015 $19.3 billion has flowed into ETFs (Exchange Traded Funds) with EuroZone exposure. That’s about double the record for any previous quarter.
Nor are financial markets showing much discrimination between the export-led economies likely to lead growth and those economies that will experience what I’d call second-hand, export-led growth.
For example, the iShares MSCI France ETF (EWQ) was up 6.6% for 2015 as of the close on March 3 and the iShares MSCI Germany ETF (EWG) was up 7.6% for the same period. That hardly seems an adequate premium given the likely difference in the performance of these two economies.
With many European stock markets trading near annual or record highs, I think it’s time for more discrimination. If the European Central Bank’s asset purchase plan works for EuroZone economies as a whole, it will work “most and first” for the strongest export economies. If it works only for some economies, it will work for the strongest export economies. And even if it doesn’t prove especially effective, it will work best for selected export-led economies.
Let me explain that last point first. Some of Europe’s strongest export economies don’t use the euro—either because the country has rejected the euro in a vote or because the country hasn’t yet adopted the euro. Denmark, for example, voted to keep its krone and not to adopt the euro in 2000 although it is a member of the European Union. Norway has kept its own krone because its voters have twice rejected membership in the European Union. Poland has been accepted into the European Union and it will eventually replace its zloty with the euro, but the timetable is rather flexible and Poland has shown no interest in moving quickly to adopt the euro.
This positioning vis-à-vis the euro has had some “interesting” side effects. Denmark, where the krone is pegged to the euro, has had to wage a concerted—and apparently successful—campaign to fend off speculators betting that the country would have to break the peg. Poland cut benchmark interest rates to 2% in October and then another 0.5 percentage points to 1.5% on March 4in order to keep the zloty from appreciating so much against the euro that the country priced itself out of some export markets. (That’s especially important to Poland since the country has become a major low-cost manufacturing base for German exporters—as long as costs stay low.) The zloty has been appreciating against the euro—despite the war in Ukraine and Russian pressure on Polish exports—because even at 2% (or 1.5%), money can earn a much better return in Poland than in the EuroZone. Those interest rate cuts certainly won’t hurt a Polish economy that seems to have recovered from a slump in 2013. Growth fell to 1.7% in 2013 before rebounding to 3.4% in 2014. Forecasts for 2015 fall in the range of 3% to 3.3%, but seem, in my opinion, to discount the effects of the most recent interest rate reductions. Poland has the potential to pull a growth surprise in 2015.
So how would I suggest investing in Europe and the EuroZone now?
I’d look to go with the region’s export led economies as the primary initial recipients of the European Central Bank’s program of asset purchases. That means, to me, starting with a dedicated Germany ETF—and one that hedges against a further decline in the euro. (Likely since the central bank’s goal in its asset purchase plan is to weaken the euro.) Three suggestions would be
• Wisdom Tree Germany Hedged Equity ETF (DXGE) with $89 million in assets, a 0.48% expense ratio, and a gain of 15.7% in 2015 through March 3
• Deutsche X-trackers MSCI Germany Hedged Equity ETF (DBGR) with $99 million in assets, a 0.45% expense ratio, and a gain of 17.7% in 2015 through March 3
• iShares Currency Hedged MSCI Germany ETF (HEWG) with $895 million in assets, a 0.53% expense ratio, and a 15.6% gain in 2015 through March 3
To that, if I were looking for more export-led, European Central Bank asset purchases, weak euro and strong domestic economy growth exposure, I’d think about adding a Poland-specific ETF. There aren’t a whole lot of choices (and please note that these are unhedged for currency risk since my opinion is that the zloty will continue to appreciate) here but I’d consider:
• iShares MSCI Poland Capped ETF (EPOL) with $171 million in assets, a 0.62% expense ratio, and a -2.24% loss for 2015 through March 3. Average trading volume is 265,000 shares a day.
• Market Vectors Poland ETF (PLND) with $18 million in assets, a 0.61% expense ratio, and a 2.77% loss through March 3. Average trading volume is thin at 8,935 shares a day.
One last thought before we leave Europe in the sunset.
It is indeed a EuroZone recovery play since the European Union is a huge market for this very small country. But buying a Norway ETF is actually a bigger play on a recovery in oil prices—Norway is a major exporter and it has been hammered by the plunge in oil prices—and on a recovery in its currency, which has also been hit by the oil price drop. Through March 3 the krone is down 21.6% against the dollar since its high for 2014 back on May 8. You might take a look at the Global X FTSE Norway 30 ETF (NORW) with $82 million in assets, an expense ratio of 0.50%, and a gain of 2.6% for 2015 through March 3.
To see how Mario Draghi’s plan is working, I’d suggest that you follow the yield on German Bunds. Yields have moved negative as traders have speculated that buying these bonds was a good trade even with a negative yield because the European Central Bank would be buying heavily and the German government simply doesn’t sell much debt. To meet its quota, then the bank, would have to entice bondholders to sell and that would drive up the price of the bonds.
Watch yields here in relation to yields on other EuroZone government debt to see if the bank’s purchase program is running into supply/demand problems in the bond market.
You can find more of Jim Jubak’s macro views and micro picks on his free site at JubakPicks.com currently hosted by MoneyShow.com or more-more-more at his subscription site JubakAM.com.
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