The euro is under threat – so invest in Germany
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Associate Editor
David Stevenson Oct 04, 2010
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At first glance, last Friday's news from Europe on the manufacturing front didn't look too promising.
The general tone was very mixed. Overall activity in the last three months saw a slowdown from this year's second quarter. And the general employment picture was patchy too.
That's not great news for continental Europe in general – and not ideal for us either. The EU is Britain's major trading partner, taking around 50% of our total exports of goods and services.
But it's not all bad news. Take the eurozone's star economy, Germany. Even here the expansion rate dipped sharply. However, dig down below the surface, and the German growth story is as strong as ever.
In fact, Germany and its stock market still look by far the best bets you'll find in the eurozone. Here's why.
Manufacturing growth is slowing in Germany
The seasonally-adjusted Markit/BME Manufacturing Purchasing Managers' Index (PMI) is hardly designed to set the pulses racing.
For economy watchers, though, it's a handy guide to what's going on in the industrial sector. This is still a very important part of most economies.
To cut a long story short, the latest PMI readings show that European-wide manufacturing is still expanding, but not as rapidly as before. Meanwhile the region's jobless level is still around a 12-year high.
Perhaps the biggest revelation was the news that the German PMI measure has hit its lowest level since January this year. In other words, that country's manufacturing growth rate has slowed down more than most, with its overall business conditions improving at their weakest rate for seven months.
Now of all the countries in the eurozone, Germany is the one we've been most bullish on. I discussed it most recently here in July: Europe's banking farce is good news for German stocks.
So should I now be eating humble pie? Actually, I don't believe so.
Germany still looks good value
Sure, German manufacturing hasn't been booming quite as it was two months ago. And new order growth has eased for the second month in a row. But the recent dip has been from near-record high levels. Further, the latest reading for growth in German manufacturing was still much higher than the long-run average.
"Activity hasn't yet returned to pre-crisis highs, but it's getting there", says Vincent Fernando in Business Insider. "It's pretty clear that Germany is experiencing one heck of a recovery".
And where it really matters – getting more people into work – Germany is doing very well indeed. The country's dole queues have been shrinking for 15 months running. Last week's jobless numbers for September showed a much better-than-expected 40,000 fall to a 7.5% rate.
That's the lowest since April 1992. And it's much better than most of the rest of Europe – or indeed, the rest of the world. In fact, last month the German Federal Labour Agency's IAB research institute predicted that Germany is set to have the highest number of people employed since the Berlin Wall came down over 20 years ago.
More importantly, this employment boom is another clear sign of the confidence that's coursing through the veins of German industry. On this score, things are looking very bright. Last week the country's IFO business climate index rose to a three-year high. This "defies any double-dip concerns for the German economy", according to Carsten Brzeski at ING.
"The German economy remains the eurozone's showcase", he says. Second-quarter growth – at 2.2% – "was exceptional and a slowdown was inevitable. But with richly-filled order books, increasing investment and production plans and a strong labour market, Germany should yield growth that could make other countries jealous".
No wonder that 2011 GDP forecasts for Germany are being upgraded. Goldman Sachs has just raised its growth estimate for Germany by more than for any other major Western country.
The key to Germany's success is selling ever more stuff to the likes of Brazil and China. It excels at it. That's because it produces exactly what fast-growing developing economies want to buy. As these countries expand, German exporters will keep on cashing in.
A falling euro is good for German exports
There is a small fly in the ointment at the moment – the rising euro. This is making the cost of German goods more expensive. But the problem is unlike to last for too much longer.
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As we explained on Friday (Why Ireland's banking woes are far from over), at some stage the financial problems in the eurozone's peripheral countries are likely to hit the single currency and drive it down again. For Germany's exporters, and also their share prices, that would be more good news.
What's more, there's another reason for buying German stocks. The locals haven't plugged into them yet. At the end of 2009, equities represented just 4% – the lowest level since at least 1991 – of the financial assets of German households. Yet they held almost 40% of their money in cash and bank deposits.
That won't change straightaway. Germans have always been quite wary about shares. But if savings deposit rates stay as low as they are now, the much better yields currently on offer from the stock market could trigger a buying rush.
Two shares to buy now
So what shares should you buy? We'd avoid banks – they have too much cash tied up in those peripheral eurozone countries.
In early June we tipped energy and chemicals giant BASF (GR: BAS), since when it's up about 12% in sterling terms. But with almost 44% of its revenues coming from outside Europe – meaning a falling euro is very handy – on a current year p/e of just over 10 and a prospective yield of 4.3%, it's still very much worth holding.
Meanwhile, global engineering firm Siemens (GR: SIE) – a long-term classic German success story – also generates around 44% of its revenues from outside Europe. Siemens is on a forecast current year p/e of 11.5 and pays a prospective 2.7% yield which is over three times covered by earnings.
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David Stevenson
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