Understanding 'Strong' Country ETF Performance

 |  Includes: DIA, EWG, EWI, EWK, EWP, EWQ, VGK
by: Gary Gordon

I recently came across a curious column that endeavored to explain strength in European ETFs. The writer used highbrow concepts like “country rotation” and “deep value.” He even credited European austerity measures for the remarkable YTD percentage gains.

Here is the data and the title that that author employed:

The Best Developed Markets Year-To-Date Through 5/4/2011
Italy (NYSEARCA:EWI) 20.5%
Spain (NYSEARCA:EWP) 20.4%
Germany (NYSEARCA:EWG) 18.3%
France (NYSEARCA:EWQ) 17.9%
Belgium (NYSEARCA:EWK) 16.2%
United States (NYSEARCA:DIA) 10.6%
Click to enlarge

Unfortunately, the blogger did not seem to have a genuine grasp on why European ETFs on U.S. exchanges are outperforming major U.S. benchmarks like the Dow Industrials Diamonds Trust (DIA). European ETF assets haven’t surged in assets under management since January, making country rotation unlikely. Moreover, the ongoing euro-dollar crisis coupled with anemic growth prospects make the “deep value” case equally doubtful.

Pointing a finger at austerity measures was at least getting warmer. However, I do not believe the wannabe financial journalist understood why austerity has been playing a part.

Here is the reality. In spite of an ongoing debt crisis and GDP woes, the Europeans have at least decided to tighten, helping the euro surge against the greenback. The euro is not too far off all time highs; the Swiss Franc has already seen that pinnacle. Indeed, as the rest of the world tightens, the U.S. Fed eases via QE2’s electronic printing and 0% interest rates. (It’s the devalued dollar, for Pete’s sake!)

So let’s look at the same data in local currencies. Are European developed markets truly the best performers, or are their ETFs “winning” due to a severe shift in the EUR/USD relationship?

Developed Markets YTD In Local Currency (Through 5/4/11)
Approx %
Italy 8.6%
Spain 8.3%
Germany 6.6%
France 6.3%
Belgium 4.8%
United States 10.6%
Click to enlarge

Now, before someone exposes me as a biased, post-bin-Laden American patriot, let’s recognize truth for truth’s sake. The fiscal austerity/policy tightening combo in Europe hinders near-term GDP growth, which may make it harder for the sovereign debt crisis to disappear. In fact, it’s likely to flare up several times before the flames get snuffed out. So the European corporations with enormous global reach are the only ones that may benefit from something other than near-term currency gains.

Did I say near-term? I did.

Granted, the long-term prospects for the U.S. dollar are extremely dismal. Nevertheless, the regular residents on the “New 52-Week Highs” list over the last month have been defensive stock ETFs and income ETFs. Any sign of stress or doubt - housing, employment, inflation, European country debt, U.S. debt ceiling, Fed shift away from QE2 - could be a catalyst for a dollar reversal. And if that happens, you’re not going to want to be caught “long” Vanguard Europe (NYSEARCA:VGK).

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.