Eric Dutram: This year hasn’t exactly been a great one to be heavily allocated to European ETFs or stocks, as worries over a euro breakup or continued recession have dashed hopes for growth and a return to normal in the region. Still, despite the gloom and doom hanging over the area, some are growing optimistic over the region, at least in the short-term.
This new found optimism is largely thanks to an extremely accommodative ECB and a relative softening of Germany’s hard-line approach to the troubled states of Europe. With Germany seemingly more supportive of struggling peripheral economies, more funds can flow to shaky nations like Spain and Italy which are increasingly becoming the epicenter of the European debt crisis.
The trend towards more accommodation and greater integration among Europe’s economies is best seen in the ECB’s recent promise to engage in an unlimited bond buying campaign in order to stabilize European debt. This new program looks to target short-term debt of troubled countries and it will be fully sterilized so the net impact on the money supply should be neutral (see For Europe ETFs, It Is Hard To Beat Switzerland).
However, it should be noted that countries will have to request help in order to receive funds and they will also need to abide by certain conditions as well. While this may eventually be a very helpful safety line for some nations, the program has already boosted confidence and demonstrated that Draghi is willing throw a significant amount of resources at the problem.
Thanks to this shift, bond yields have plummeted in many of the weakest economies in Europe and especially so in the trillion dollar peripheral economies. In fact, Spanish 10 year notes have retreated roughly 200 basis points from their 52-week highs while Italian notes have fallen by a similar amount, helping to crush near term worries over a bond market collapse in either of these nations (read Spanish Bailout: Did It Help European ETFs?).
The program, as well as the hopes of more German support, has also sent European ETFs in the periphery skyrocketing over the past month. The troubled nations have actually seen some of the best performances over the past few weeks, pretty much entirely erasing the negative months earlier in the year.
In fact, of the top four best performing country-specific ETFs over the past month, according to XTF.com, three are European funds targeting weak nations. These performances haven’t been anything to sneeze at either, as the Italian Fund (NYSEARCA:EWI) and the Spanish ETF (NYSEARCA:EWP) added at least 13% each, while the Greece ETF (NYSEARCA:GREK) gained a whopping 20.6% in the time frame (see Beyond Germany: Three European ETFs Tracking Strong Countries).
Thanks to this incredible short-term performance, EWI is actually up almost 9% year-to-date while GREK and EWP are now posting a loss of less than 4% in the same time frame. Clearly, these funds have been quite volatile this year, but it does finally appear as though some might be turning things around.
With all this being said, investors should remember that we have been here before with Europe and that peripheral ETFs have seen solid performances in short time periods when other bailout measures were announced. None of these bounces really stuck, leaving European ETFs in freefall mode once again (read Beyond The PIIGS, Three Troubled European ETFs to Watch).
This situation could especially be the case this time around, particularly if investors have miscalculated how accommodative Germany is going to be in regards to its more free-spending counterparts. After all, Jens Weidmann, the German central bank president, was the only one to declare that he was not in support of the bond buying of the 22-person ECB council.
In a press release the outspoken president declared that the bond buying was ‘tantamount to financing governments by printing banknotes’ suggesting that the most important member of the ECB could pose some staunch opposition to the program. Additionally, more roadblocks to the program actually being put in place could come thanks to either German parliamentary actions or evenGerman constitutional court rulings, suggesting that the bond buying scheme could be dead before it even begins.
Given that no one really knows how Germany will come down on the issue, the euphoria over the bond buying may be a bit premature. Seemingly, the best that Europe can hope for is that even the mere proposal for bond buying by the ECB will continue to drive rates lower, possibly to a point in which a bailout isn’t even needed anymore (see Play Europe with This ETF Pair Trade).
As with anything in Europe, this will likely be dragged out for months and no definitive solution will transpire. Instead, it seems as though Germany will use its influence in order to pull other European nations closer to its line of thinking, but all the while slowly coming around to more intervention in the bond markets by the ECB.
With this backdrop, it is hard to say whether troubled European ETFs are truly back on track or if the market is taking this as an opportunity to bid up beaten down shares in nations like Italy and Spain. The next few weeks and months will hopefully provide more clarity on this situation, but as of now it does appear that the ECB’s threats are having their intended impact on the market.
This suggests that at least with this powerful force behind them, once weak European ETFs could continue to stay in a stable holding pattern, until of course the next roadblock appears in this saga. As a result, underlying country fundamentals are not really very important anymore with this segment, and it is all about the ECB at this point in time.
Seemingly, no importance should be paid to how unfavorable underlying conditions might get in individual countries, so long as the ECB is willing to intervene or threaten to get more involved in the markets. For this reason, it is hard to believe that the troubled European ETFs are back on track for the long term and that instead a true realignment will be necessary in the space before investors can have any real level of confidence in the markets besides from what the ECB can do to prop up the market.
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