Finding value in today’s markets has been difficult, so it’s no surprise that many investors are turning to opportunities outside of the U.S. But where should they look?
We think the eurozone, and in particular Germany, looks attractive due to several factors:
Quantitative easing (QE)—The European Central Bank’s (ECB) $1.1 trillion bond-buying program has pushed yields to negative territory in some cases, driving investors toward dividend-paying stocks to seek income.
Valuations—European stock valuations are low relative to other global markets. As the regional European economy gains momentum, now may be a good time to consider investing for the potential growth ahead.
Currency—Export-oriented companies in the eurozone, and especially German companies, may benefit as the weakened euro can help improve their revenues.
Let’s take a closer look at how these catalysts can benefit the U.S.-based investor.
Powerful stimulation
ECB President Mario Draghi’s ground-breaking QE program was meant to be a turbo engine to manage inflation—or help to fight deflation in this case, as inflation has already dipped into negative territory (-0.6% as of February, according to Bloomberg data)—and to boost growth.
The QE program should benefit the region in several ways. First, the cost of capital has improved, so companies may be encouraged to borrow to increase shareholder-friendly policies for investors, such as dividends and share buybacks.
Second, Europe issues significantly fewer bonds than the U.S. Citi estimates the ECB could source up to 89% of their bond purchases from existing holders rather than from new issuances. With the bank’s high demand for bonds, yields, already low, have been pushed to nearly zero or lower. (Source: MSCI)
In the case of Germany, MSCI data tells us that 51% of its bonds trade below zero. Put another way, government bond investors are now paying the government to take their money.
European stocks, on the other hand, have been delivering an average dividend yield of more than 2.5%, according to MSCI data as of February 27, 2015. Institutions have already been buying up European equities, and individual investors are expected to follow.
Stocks still cheap
As Europe begins its recovery, its stock valuations appear attractive compared to U.S. equities. According to MSCI data, Eurozone stocks are currently at a 40% discount, in price-to-book terms, to the U.S., which looks good compared to the long-term average of approximately 35%.
And German stocks look even better when compared to the rest of Europe. Germany currently sits at a 15% historical price-to-earnings discount to the eurozone and at a 32% discount relative to the U.S. (Source: MSCI) According to Bloomberg, German companies also have strong balance sheets, holding approximately one-quarter of Europe’s cash. This could encourage them to issue debt and retire stock, which should be good for equity returns.
Currency tailwind
As the ECB kicks off its QE, the U.S. is ending its own stimulus programs. Here at home, our economy is relatively strong and interest rates are expected to rise later this year.
This divergence in economic policy is the major factor behind a weaker euro. Bloomberg data shows that the euro has fallen nearly 20% against the U.S. dollar since last summer. And we believe this trend could continue for a while.
Although the stronger dollar-to-euro exchange hurts the earnings of some U.S.-based exporters, it should be a tailwind for European companies. It translates into cheaper exports for them, particularly those companies that are cyclical in nature and can take advantage of growing U.S. demand for its products.
And Germany in particular, as Europe’s largest economy and fifth largest exporter to the U.S., could benefit significantly. Its major exports are cars and pharmaceuticals, two sectors which could see increased sales as our economy improves.
The weaker euro could, therefore, provide a direct boost to the earnings-per-share of export-oriented companies. This can occur because the exchange rates are baked into top-line revenues—something that many analysts may have overlooked because of the speed of the currency move.
However, some of that potential equity gain can erode when your investment in the eurozone is translated back into the stronger dollar. That’s why currency hedged investments in Europe and Germany should be considered for the near term.
Potential ways to access the European markets
An easy way to access these markets while hedging against currency risk is through the iShares Currency Hedged MSCI Germany ETF (HEWG) and iShares Currency Hedged MSCI EMU ETF (HEZU). As of March 30, 2015, the majority (53.3%) of HEWG is invested in the consumer discretionary, financials and health care sectors, which can provide investors exposure to the potential U.S. demand for German goods and services*. HEZU offers broader eurozone exposure.
And if you want to more actively shape your view on the currency, you can pair these hedged funds with our unhedged versions: iShares MSCI Germany ETF (EWG) and iShares MSCI EMU ETF (EZU).
To learn more about the eurozone’s economic outlook, read the recent BlackRock Market Perspectives and a white paper I’ve written with my colleague, Chief Investment Strategist Russ Koesterich.
Heidi Richardson is a Global Investment Strategist at BlackRock, working with Chief Investment Strategist Russ Koesterich. She is also the lead investment strategist for iThinking. You can find more of her posts here.
*Holdings subject to change. For a full list of the current fund holdings, please click here.
Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.
The iShares Currency Hedged Funds’ use of derivatives may reduce the Funds’ returns and/or increase volatility and subject the Funds to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. The Funds could suffer losses related to its derivative positions because of a possible lack of liquidity in the secondary market and as a result of unanticipated market movements, which losses are potentially unlimited. There can be no assurance that the Funds’ hedging transactions will be effective.
This material represents an assessment of the market environment as of the date indicated and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any security in particular.
The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.
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