Searching For Stability With Germany ETFs

Germany, the eurozone's largest economy, is often seen as a beacon of stability, particularly at times when volatility is high for the region's equity markets. This year, however, exchange-traded funds tracking German stocks have betrayed that stable reputation as the euro strengthened amid investors' perceived disappointments courtesy of the European Central Bank (ECB).

For example, the iShares MSCI Germany Index Fund (ETF) (NYSE:EWG), the largest Germany ETF trading in New York, is down about 2.6 percent year-to-date. Over the past year, EWG is lower by 16.7 percent, putting the titan of Germany ETFs dangerously close to being in a bear market.

That is a slack showing to be sure for EWG, but that does not mean the news is all bad for German stocks and corresponding ETFs. Germany is still home to a current surplus, a diverse economy and an impressive AAA credit rating.

There's Still Strength In Germany

The 'AAA' ratings primarily reflect Germany's strong institutions and diversified, high value-added economy. A large structural current account surplus supports the country's net external creditor position. Government debt (71.6 percent of GDP in 2015) is higher than the 'AAA' median (43.3 percent) but is on a downward path. In Fitch's view, Germany has sufficient fiscal space to manage the migrant crisis without negative rating consequences, said Fitch Ratings in a recent note.

In that note, Fitch affirmed Germany's long-term foreign and local currency Issuer Default Ratings (IDRs) at 'AAA' with stable outlooks.

Although it is not a currency hedged ETF, EWG could use the benefit of a weaker euro because the fund devotes more than 20 percent of its weight to consumer discretionary stocks, its largest sector allocation. The Deutsche x-Trackers MSCI Germany Hedged Equity ETF (DBX ETF Trust (NYSE:DBGR)) would really like to see the euro slide, as that currency hedged ETF is down more than twice as much as EWG this year.

The $121.6 million DBGR also allocates more than 20 percent of its weight to consumer discretionary stocks. With strong underlying fundamentals and equity valuations that are still below those of U.S. stocks, it can be argued that investors are not fully appreciating German stocks and ETFs like EWG and DBGR.

Germany's current account surplus widened to an estimated 8.3 percent of GDP in 2015, from 7.2 percent in 2014, largely due to the low oil price and euro depreciation. In line with a weaker export outlook, Fitch expects a moderate reduction in the current account surplus but still remaining above 7 percent of GDP over the next two years. We forecast Germany's net external creditor position to strengthen further, to 25 percent of GDP in 2017 from close to 16 percent in 2015, added Fitch.