Europe's Giant Is Set for a Rebound

06/18/2009 11:00 am EST

Focus: ETFS

Jon Markman

Editor, Trader's Advantage

Jon Markman, contributor to MSN Money, says Germany’s economy is likely to recover fast if consumers start spending again, and the pessimism about it is way overdone.

The center of the industrial economy in Europe is Germany, and what a disaster it has become in the past year and a half. The German economy plummeted at a record pace in the first three months of this year, by around 14.4% annualized, or more than twice as much as the US decline. Exports fell 9.7% in the first quarter, and business investment fell 7.9%.

But there is a growing sense now that businesses and consumers worldwide cut back on their orders for European goods more sharply than called for by economic conditions last winter, giving the efficient German economy an opportunity to defy its critics and stage a stunning rebound.

Manufacturing orders and exports rose in April, and business confidence is advancing sharply. Consumer spending rose 0.5% in the first quarter. And fiscal stimulus ordered by Chancellor Angela Merkel has been much stronger than expected: at least $115 billion already, and counting.  German stocks rose 16% between April 1st and May 25th, as forward-looking investors tried to bet on a lasting, if slow, recovery.

So, economists and policymakers must be excited, right? Not at all, as most shell-shocked analysts who failed to foresee the downturn now give the Continent little chance at making a full recovery in the next few years, much less the next few months, calling it a drag on the global economy.

Yet this pessimism may be an overreaction (see last week’s Global Q&A), if recent industrial output trends are to be believed. German business confidence rose to a six-month high in May, pointing at minimum to stabilization at a relatively low level. Pessimism is so deep that lousy expectations will be relatively easy to surpass.

Why could Europe shock the world by not falling into the Atlantic as quickly as pessimists expect? If demand from China, India, and other emerging markets for German machinery picks up as much as current forward-looking data suggest, factories will be humming again soon, and the period of lag when consumers paused will look slim.

For the least risk in the most diverse [European] economy, you may wish to start with iShares MSCI Germany Index (NYSEArca: EWG). This is a country where big business really is big. Just seven companies–Allianz (NYSE: AZ), Siemens (NYSE: SI), drug maker Bayer (Xetra: BAYE.DE), business software maker SAP (NYSE: SAP) chemical maker BASF (Xetra: BASF.DE), and carmakers Daimler (NYSE: DAI), and Volkswagen (Xetra: VOW.DE)—account for 49% of the ETF's holdings.

Expectations are dismal, which means that news doesn't have to be good to support shares—just not catastrophic.

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