This is a significant break from the past, with the 3 week daily correlation at a 4 year low of -0.5092.
This relationship breakdown is part of a long line of shifting relationships in the capital markets. These breakdowns in correlation include the Aussie dollar (NYSEARCA:FXA) with the S&P500 (NYSEARCA:SPY), oil (NYSEARCA:USO) with the SPY, the U.S. dollar (NYSEARCA:UUP) with the SPY and Gold (NYSEARCA:GLD) with everything. I see all these breakdowns as confirmation of a larger shift out of commodities and the end of an era, the commodity super cycle circa 2002.
The Implications of the Divergence Between FEZ and FXE
What is especially surprising of the divergence between the FEZ and FXE is that the data in Europe has been all but inspiring. Taking just this week alone, Germany's economic sentiment and Europe's economic sentiment worsened in the ZEW Survey, France was confirmed as being in a recession, Germany's GDP missed expectations to the downside, Italy's GDP missed expectations to the downside, and in fact, the entire EU region's GDP missed to the downside.
Below are charts recapping each of these events.
A worsening EU economic picture has obvious implications for the euro, as a worsening eurozone raises uncertainty around future monetary policy, not to mention the future of the euro, and uncertainty is costly. The question is why doesn't this ring true for European companies?
The hypothesis for my investment in the FEZ, as I wrote back in August 2012, is that the governments of Europe are not the same as the companies in Europe. From my original article:
The most crucial aspect of the FEZ is the underlying companies and their prospects going forward. Although Europe is a quagmire, whatever the outcome it is highly improbable the people of Europe will stop depositing money in banks, using oil, drinking beer or go without the other luxuries of modern life. It is also highly improbable that the rest of the world, especially the masses who for the first time are realizing the benefits of capitalism, are going to go without these goods.
This is as true now as it was nearly one year ago. In fact, it is truer than I knew at the time that I wrote it, as I'm currently in the town of Passau in the south of Germany, and the shopping is nearly identical to what I could find in Canada or America. In fact, one shop even had shirts with pictures of Times Square on the front to entice shoppers into the store. The future is now.
With equities all the rage, EU companies are cheap and pay higher dividends when compared to their U.S. counterparts, which I outlined in another previous article found here. In addition, a weakening euro will increase the value of the cash these companies receive for the goods they sell outside the eurozone, so a worsening eurozone coupled with a stronger world economic picture isn't as bad as it may appear for European companies. Of course, a booming world economic picture would be the ideal, but that appears increasingly unlikely in the near term.
As investors around the world look for companies worthy of their capital, they'll be faced with a choice. They can either buy a company like Chevron (NYSE:CVX), which is trading at a price to book of 1.75 and yielding a dividend of 3.26%, or buy a company like Total SA (NYSE:TOT), which is trading at a price to book of 1.19 and yielding a dividend of 7.54%. They both sell similar goods to world markets, but a difference in valuation arises largely due to the location of each headquarters. In fact, Total returned more to shareholders in 2012 than Chevron, Exxon (NYSE:XOM), BP (NYSE:BP) or Shell (NYSE:RDS.A), all while improving its balance sheet.
Total is FEZ's 2nd largest holding, but the global nature of its operations will be a feature of all the companies in the FEZ, as it is made up of the largest 50 companies in Europe, and you don't become one of the 50 largest companies in Europe without doing business around the world. Below is a list the top 10 holdings of the FEZ. Many of these companies you'll be aware of no matter where you're reading this from.
The major takeaway from the divergence between the FEZ and FXE is that European companies are beginning to be recognized for what they are -- global corporations, not proxies of their governments. No matter what the outcome is in the eurozone, as long as civilization doesn't collapse in on itself and we are forced to start bartering with gold coins (a real possibility, according to some pundits), these companies will continue to deliver the products and services that enable us to enjoy our standard of living.
They can also increase your standard of living if you choose to invest in them via the FEZ, which I advise you do.
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.