Top EU Bets? Germany and Switzerland

08/13/2013 9:00 am EST


Mark Salzinger

Editor and Publisher, The No-Load Fund Investor

Stocks in Germany and Switzerland have been among the best of a weak bunch of foreign markets so far this year, with ETFs up about 8% for the former, and 14% for the latter, reports Mark Salzinger, ETF expert and editor of The Investor's ETF Report.

Both countries enjoy positive economic fundamentals, despite regional weakness, and the ETFs representing them have moderate valuations and favorable composition.

The European Union (EU) is the largest trading partner of both Germany (about 57% of all exports go to the EU), and Switzerland (half of all exports).

Of course, this relationship with the currency bloc has checked economic expansion in both nations.

The economy of the euro area (the nations whose currency is the euro) contracted 1.1% in the first quarter of 2013, keeping German GDP growth to 0.1% and Swiss growth to 1.1%. The International Monetary Fund recently cut its estimate for German GDP growth in 2013 in half, to 0.3%.

Even so, German unemployment recently reached a two-decade low of 5.3%. Indicators of business confidence, capacity utilization (a measure of how much of Germany's industrial production capacity is actually in use), inventories, and bankruptcies have recently all been conducive to economic growth.

Consumer spending and disposable personal income have also been steadily on the rise. The IMF expects German GDP growth to accelerate to 1.3% in 2014.

Economic growth in Switzerland is among the fastest in Europe. The unemployment rate in the country was recently just 2.9%. The Swiss National Bank has maintained a zero-interest-rate policy to keep the value of the Swiss franc from rising too much, relative to the euro.

These efforts have held the value of the franc relatively steady compared to both the euro and the US dollar over the past two years, while the inflation rate has been persistently negative.

This alleviates any potential pressure to raise interest rates and boost the franc's value, helping the global competitiveness of Swiss multinationals.

iShares MSCI Germany (EWG) and iShares MSCI Switzerland (EWL) continue to have relatively attractive valuations.

EWG recently sported an average price/earnings (P/E) ratio on 2013's projected earnings of 12.6 and a price/book value (P/B) of just 1.4.

EWL has higher average valuations (P/E of 15.7 and P/B of 2.3), which are not unreasonable given that EWL has been one of the top-performing European single-country ETFs over the past three years (three-year-annualized return of 14.7%).

The sector compositions of the German and Swiss economies and their respective ETFs have helped recent performance. Neither EWG nor EWL has significant exposure to energy stocks, which have done relatively poorly for the past 18 months.

EWG has some exposure to materials stocks (about 14% of the portfolio), but most of its exposure in that sector is in chemical companies (BASF accounts for more than half of EWG's materials position) rather than poorly performing metals, mining, and fertilizer stocks.

EWL has about 8% of its portfolios in materials, also mostly chemical companies.

EWG and EWL have been buoyed by significant allocations to financials (17% and 21%, respectively), healthcare (13% and 29%, EWL's largest sector allocation) and industrials (14% and 11%). EWG has its largest sector stake in consumer discretionary stocks (21%).

EWL is somewhat top heavy: its top ten positions recently accounted for more than 70% of its assets, and three positions—staples giant Nestle, and pharmaceutical leaders Roche Holdings and Novartis—each get at least 13% apiece.

About 59% of EWG is in its top ten positions, none of which account for more than about 9% of the portfolio.

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