iShares Netherlands: Visit Amsterdam, But Invest Elsewhere

May. 9.13 | About: iShares MSCI (EWN)

I arrived in Amsterdam two days ago and set sail up the Rhine last night, beginning the journey to Budapest.

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Although Amsterdam is home to only 800,000 people (16,782,300 in the entire country of the Netherlands), it is a happening city and one of my favorites. The street level commerce rivals Hong Kong, and all the locals I met had a hustle of one kind or another. This is consistent with Amsterdam's culture, as it has long been a center of commerce, and was the wealthiest city in the world in the 17th century.

In fact, all Seeking Alpha readers owe a sense of homage to Amsterdam, as it is home to the world's oldest stock exchange, the Amsterdam Beurs founded in 1602.

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Netherlands: The Macro Picture

With this rich history of commerce, it is worthwhile investigating whether the Netherlands is a place to put capital to work.

In terms of GDP, the Netherlands is a formidable European economy with a yearly GDP in Euros of €602 billion, making it the 6th largest in the region just behind Spain. It also boasts a higher GDP in Euros per inhabitant than all the countries with larger GDPs.

The graph below has the GDP size on the vertical axis as well as indicated by the size of the bubble, the horizontal axis is the GDP per inhabitant. Therefore, the higher and larger the bubble, the more total GDP in Euro terms, the farther to the right the bubble, the more GDP per person.

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In terms of GDP growth, the picture isn't as rosy, with the Netherlands forecasted to grow slower than France in 2013, putting it at the bottom of the pack with Italy, Cyprus, Greece and Spain.

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Also of note is the historic trend of GDP growth in the Netherlands. This chart goes back to 2000, and the Netherlands was consistently at the bottom of the pack in terms of GDP growth. There may be more fundamental regulatory and policy issues at the heart of the Dutch economy to be dealt with.

Interestingly, despite this poor growth rate, unemployment is low. The Dutch boast the 2nd lowest unemployment rate of the major EU countries after Germany.

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The unemployment rate has been accelerating since July of 2011, a disturbing trend.

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The low unemployment rate begins to make sense when the labor laws are taken into consideration. The labor laws in the Netherlands feature the following characteristics:

  • In order to dismiss an employee, permission must be granted by the UWV WERKBedrijf, who will only grant permission if it is convinced a serious reason for termination exists.
  • Even with permission from the UWV WERKBedrijf, an employee can appeal the process and claim further financial compensation or reinstatement of their employment contract.
  • UWV WERKBedrijf guarantees unemployment benefits of 75% of your last earned wage for the first two months and 70% thereafter depending on circumstances, which could be a relatively generous sum. This is available for a maximum term of 38 months, or a little over 3 years.
  • The Netherlands has the 3rd highest minimum wage laws of the countries tracked by Eurostat at €1,469 per month. The table is below.

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These labor laws haven't been crippling, as the Netherlands is still relatively prosperous, but requiring employers to apply to a board to dismiss an employee, as well as leaving an open ended liability despite the board's ruling, results in significant economic inefficiencies. The main costs to an economy from such a policy is imbalance in the allocation of labor capital, as employers will be hesitant to dismiss employees to avoid the hassle of dealing with the labor board. Policies like this, although politically popular, are foolish, as this misallocation of labor capital lowers the standard of living and delays the progress towards a post-scarcity society, the endgame that policy makers appear oblivious to.

Although there is talk of reform, labor reform is seldom a quick and easy process, meaning that these inefficiencies are here to stay in the near term. This is unfortunate, as in majority of the other measures of economic freedom the Netherlands does well and is overall ranked 17th in economic freedom in the world.

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Moving onto trade, the Netherlands does a tremendous amount of business with Germany, followed by Belgium, the United Kingdom and France.

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Broken out for exports and imports in percentage terms, Germany accounts for over 30% of exports and close to 25% of imports, with the next closest of Belgium at around 15% for both measures.

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When the red line outstrips the blue line, it demonstrates a net trade surplus. Overall, the Dutch have been doing well against the majority of their largest trading partners, with large surpluses in trade with Germany, France and Belgium. China is their largest trade deficit at €24 billion.

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I'm not a mercantilist, and don't subscribe to the notion that a trade surplus is good and a trade deficit is bad. This world view loses sight of the fact that the only way a trade takes place in a market economy is via a mutually beneficial exchange. Therefore, rather than trade surpluses or deficit is being viewed as either good or bad, I view trade in and of itself good, and no trade or policies that restrict trade as bad.

In this sense, Netherlands is a standout with regards to trade, with trade as a percentage of GDP in the upper echelons of European countries.

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This participation in trade indicates that the prosperity of the Netherlands will be tied to their largest trading partners. In particular, it appears with Germany goes the Netherlands.

The government of the Netherlands is in a relatively good position, with government debt to GDP 2nd only to Denmark at 71%.

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The deficit picture is of concern, as the Netherlands have been unable to pull out of a deficit situation since 2008 and are currently running a deficit of 4.1% of GDP. Therefore, although their government debt is in better position than countries such as Germany, Germany has a budget surplus.

Much like my previous article on Denmark, the government debt picture doesn't tell the whole story. Households in Netherlands also leveraged up, likely as a result of the social safety net, and they boast the 2nd highest household debt to GDP figures in the EU area.

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Much like Denmark though, the people of the Netherlands have already begun deleveraging.

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The nature of the leveraging and deleveraging in the two countries differs. Whereas Denmark leveraged up in the boom times and began deleveraging sooner, the Netherlands leveraged their debt to income over 6% from 2008 to 2009.

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I see this as being indicative to how close the citizens of each country are to "living on the edge." In Denmark, the large reduction in economic activity didn't force them to take on a large amount of household debt, in the Netherlands it did.

The inflation data is an oddity in the Netherlands. While the inflation rate in the rest of the EU is trending downwards, the inflation in the Netherlands has trended upwards and is currently at 3.2%, above the usual 2% targeted by central banks. The Netherlands uses the Euro, limiting their options to deal with inflation.

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The trend is the largest concern in this data, as with the rest of Europe trending down and the Netherlands trending up, a difficult situation emerges. The Economist wrote an excellent piece on a Dutch exit from the Euro back on March 5th of 2012, and although there has been little talk of this since then, if inflation continues to deviate from the rest of the Euro region, an exit may have to be looked at more seriously.

Investing in the Netherlands

Although there are a multitude of ETFs that provide exposure to the Netherlands, there is one entirely concentrated on the country, the MSCI Netherlands Index ETF (NYSEARCA:EWN). It is trading well off its post 2008 low of 10.72, but well short of the pre-2008 high of 32.66.

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Since 2009, EWN has lagged the S&P 500 (NYSEARCA:SPY) index by half, with returns on the S&P 500 of 85.20% versus 49.78% for EWN, but has outperformed the Euro Stoxx 50 Index (NYSEARCA:FEZ).

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Year to date, the EWN and FEZ have both had returns of 6%, versus SPY's 14.75%.

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When you purchase EWN, you are essentially purchasing 10 companies, as over 70% of the ETF is made up of these companies.

I've broken the valuation metrics of these companies in the table below:

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I was surprised to see that despite the low growth rates and troubles in the EU, these companies are trading at a premium collectively. This may have something to do with the sector, as the ETF is heavily weighted towards consumer defensive companies, largely due to the high weight of Unilever in the ETF.

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With the economic uncertainty in the EU, consumer defensive would be expected to be expensive relative to other sectors.

When the ETF is looked at in its entirety, it continues to look expensive, trading at an overall P/E of 23.12 and a price to book of 3.76. The SPY currently trades at a P/E of 14.74 and a price to book of 2.34. They have almost identical dividends of just below 2%.

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The Bottom Line

Amsterdam is a beautiful city and the Netherlands a beautiful country, but at current valuations, the EWN is expensive relative to its counterparts in Europe offering a poor risk to reward scenario. In addition, from a sector rotation perspective, I see this as a suboptimal time to be overweight consumer defensive stocks.

I've written extensively about the FEZ and highlighted the superior value it currently boasts when compared with similar US equities, and after investigating Denmark's ETF (BATS:EDEN) and EWN, FEZ continues to be my top pick in the European region.

Disclosure: I am long FEZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.