An Update On German Stocks And The German Stock ETF

Includes: EWG, VEA
by: Lawrence Weinman

German Stock Update…

I thought I would check in on the recent performance of the German stock market and the ETF EWG, which I wrote about a few weeks ago as potentially a surprise upside performer for 2012. While it is too early to draw any firm conclusions, here is a review of where things stand as the first 2 months of 2012 draw to a close.

The Germany ETF total return YTD is 19.3% compared with 11.0% for the developed markets VEA and 8.9% for the S+P 500 (NYSEARCA:SPY).

Both the fundamental and technical outlook for Germany looks positive. Earlier this year it seemed investors were looking past the Greek crisis and back at the fundamentals of the German economy. Now that there is an agreement, albeit a weak one on Greek debt, the sentiment has become more positive. Additionally, the German ETF, which is priced in dollars, has benefited from the strengthening of the euro.

Fundamentals: Improving and More Positive than the Rest of Europe

Fundamentally there is increasing evidence of a bit of a decoupling of the German economy from most of Europe. The European Commission has released a report concluding 10 European countries, notably Greece, Italy and Spain, are about the fall into recession. The outlook for Germany and France meanwhile is considered considerably brighter.

This is reflected in the recently released IFO institute monthly business climate index, which reached its highest level since July of last year, reflecting expectations of business conditions for the next six months.

The German market, which generally trades at the same valuation as the U.S. market is still trading at around a 20% valuation discount to the U.S. market (13 for SPY vs. 11 for EWG) so a reversion toward the mean in valuation offers a good bit of price appreciation potential.

Technicals: Positive as Well

While I would not label myself a pure technician, long experience in the markets, particularly my early experience in the currency markets and commodity markets where these are used intensively, has given me some good familiarity with this mode of analysis. I certainly always take a look at the technicals and when they line up with a fundamental story, as they almost always do, attention should be paid.

In my last article I pointed to some potential technical indicators that would reinforce the positive case for the German market (specifically EWG); both technical indicators have developed during February.

Moving average crossover. The 50-day moving average (shown above) was crossed over by price late last year. The slower 200-day moving average, a slower indicator, was crossed this month. The latter is seen as a strong confirmation of the price momentum and trend.

Resistance Level/Chart Patterns: I pointed out that a breaking of the previous high of 22 would be a bullish indicator and would indicate further upward potential; a strict reading of the chart would see the next resistance level at 26. At the market close on Feb. 24 EWG was at $23.17.

Technicians also look at the piercing of the 2/3 retracement of the last major price move. Measuring based on the decline from $28.7 to $17.5 that would put the level around $24.5. At the time of writing EWG is at $23.17. Technicians watching this indicator would look for the price movement after that to lead to 100% retracement to $28, a gain of another 20%. Given that the U.S. market is already above that retracement level the target does not seem unreasonable. This is the case particularly given the German market's current undervaluation, which is out of line with its traditional valuation at or above the U.S. valuation. As noted Improvement in the valuation of German stocks would give further positive price impetus and also implies a further 20% gain.

With the fundamentals and technical lining up and at least a temporary reprieve from a major European debt crisis, it deems German stocks are indeed lining up as the positive surprise for the year. Once again conventional wisdom (negative on all European markets at year-end 2011) does't give a very useful forecast

Disclosure: Mr. Weinman's clients have positions in EWG