Time To Go Long Europe—Without A Hedge

April 21, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Susanne Alexandor, who leads the private client business and is a senior member of the investment team at Toronto-based Cougar Global Investments.


The list of reasons to be cautious about Europe still seems long. Deflation; low growth; high unemployment; the possibility of Greece leaving the eurozone—the so-called Grexit; politics; and worries over what Russian President Vladimir Putin might do all come to mind.


However, after exiting our European positions last year because of all of the above, as well as a general preference for the U.S. market, we recently invested in Europe once again.


After waiting for a long, long time for the European Central Bank (ECB) to initiate a convincing QE easing program, ECB head Draghi did not disappoint, delivering a larger-than-expected package. While the effects and success will be analyzed and debated, one important result of the relative monetary policy divergence between the Fed and the ECB was the quick decline of the euro versus the dollar.


Not Just Germany

This decline should help lift inflation expectations in Europe, and even more importantly, help exports. Europe is the largest exporter in the world, and recent manufacturing surveys are pointing to an upturn. While, for several years, Germany—Europe’s largest exporter—was the bright spot, its unemployment rate of 4.8 percent, enviable by any standards, is at a 33-year low.


But other countries now are showing signs of improvement. Notably, economies that have made progress with structural reforms, such as Spain and Ireland, are experiencing expanding manufacturing activity, and other large exporting countries such as Netherlands and Italy will become more competitive with the lower euro.


Meanwhile, consumers across Europe are benefiting from the combination of lower oil prices and less fiscal austerity. Recent economic data is encouraging, showing a pickup in consumer and retail confidence. While the Greek saga continues to unfold and could cause volatility, the current backdrop should spell even more good news for eurozone stocks.


Where To Invest?

To achieve a diversified approach to a basket of European countries, we selected EZU, the iShares MSCI EMU ETF (EZU | B-79). Other noneurozone countries may also offer opportunities, but the ramifications of Denmark defending the currency peg, the Swiss abandoning its currency peg, and next month’s U.K. election leave us preferring the eurozone.


We also noticed how individual country’s markets are dominated by a small number of sectors. Among the noneuro markets, the U.K. and Norway have large exposures to energy, while Switzerland is dominated by health care.


The German stock market is dominated by three sectors—materials, industrials and consumer goods. It has comparatively low exposure to financials, and no exposure at all to energy. A similar pattern is observable across other countries. Spain is dominated by financials and consumer services, Netherlands by energy and technology, and Italy by energy and financials.


By combining the countries on a market-capitalization-weighted basis as EZU does, the resulting sector exposure is much more diversified, and consistent with the sector weights of the MSCI World.


EZU Not Currency-Hedged

Finally, this ETF does have underlying exposure to the euro, even though EZU’s hedged cousin, the iShares Currency Hedged MSCI EMU ETF (HEZU | D-42), is available to investors who want EZU, but with a hedge.


While continued monetary policy divergence could give further support to the dollar, much of this is already reflected in the current exchange rate. The path of rising U.S. rates is likely to be gentle, and if the investment thesis we outline plays out, the euro should benefit as well. 



At the time this article was written, Cougar Global Investments held a position in EZU in some of its asset allocation models.

Cougar Global Investments, founded by Dr. James Breech, is a Toronto-based global tactical ETF portfolio strategist that uses only ETFs in its top-down global asset allocating strategies. Breech launched Cougar in 1993 around a downside risk management system he created. Contact Cougar Global at 800-387-3779 or at [email protected].


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