Don’t Give Up on Europe
Government balance sheets in Europe are already stretched as these economies struggle to stay above water. A drastic slow down in US economic growth would strike a significant blow to the EU’s main economies. Not only are the US and EU economies connected by trade and finance, the US economy is a barometer of European growth. If the US economy relapses, Europe will likely follow suit in about a year and a half.
The eurozone’s direct exposure to the US economy is relatively small in absolute terms. The EU’s exports to the US, in nominal US dollars, represent around 2 percent of gross domestic product (GDP), down from 2.6 percent 10 years ago. Ireland has the highest exposure, with exports to the US accounting for 16 percent of GDP in 2010. Belgium follows with 3.4 percent, and German exports represent 2 percent of GDP.
Nevertheless, a pronounced slowdown in the US economy would affect Europe through indirect channels, essentially by influencing trade with non-European countries. Lower US demand would drive down exports for a number of countries, leading to declining imports from the eurozone. In some respects, the indirect effects of a US recession would be more pronounced than the impact on direct trade.
Given this macroeconomic outlook, we’ve long believed that France’s market–which features a high beta–would outperform the rest of Europe. Consequently, in October we recommended investors purchase shares of iShares MSCI France Index (NYSE: EWQ)
Prior to the recent turmoil, the investment case for this exchange-traded fund (ETF) played out as expected. But the recent market panic has caused the ETF to draw back.
France’s economy performed strongly in the first half of the year, which should allow for full-year GDP growth of about 2 percent. However the country’s economy may expand by less than 2 percent in 2012 if the US and EU economies continue to weaken.
France’s economic performance will be driven by private consumption through next year, although rising commodity prices and an uncertain economy may hurt consumer spending. The country’s public deficit in 2011 should remain less than 6 percent of GDP–a positive development. But the deficit could increase in 2012, which is an election year in the country.
We continue to recommend that investors buy into France during periods of weakness. The ETF offers solid growth potential with a portfolio of resource- and infrastructure-related companies. The fund boasts a dividend yield of 3 percent, a result of its exposure to pharmaceutical and telecommunications names. Buy iShares MSCI France Index up to USD30.
Hedge with Gold
Gold remains one of best ways to hedge a long-only portfolio, especially during times of uncertainty. The yellow metal has three characteristics that make it one of the most unique assets in the world. It’s relatively scarce, easily broken apart and transported, and it’s almost impossible to destroy.
Gold can perform well during inflationary and deflationary periods. But the yellow metal truly shines when governments devalue their currencies through money printing, as is the case today. The US dollar is the world’s reserve currency, and consequently the fate of the greenback poses the greatest threat to the global economy. America’s political and economic leadership has systematically abused the currency’s privileged position for years. The result has been growing unease among nations that have accumulated reserves of US dollars. In fact, these countries have started to demand assurances about the dollar’s future before committing to further purchases. In addition, global central banks have also stepped up their purchases of gold.
We maintain our bullish outlook on gold, although we expect periodic pullbacks. Nevertheless, continued economic uncertainty in developed economies will bolster the price of the yellow metal. Buy SPDR Gold Trust (NYSE: GLD) at current prices.