The Eurozone problems are not new by any stretch of the word. Investors have been anticipating a full fledged economic recession since early 2011, before the problems reached alarming levels during the latter half of previous fiscal.
The impact of this was felt throughout the world, both in emerging as well as developed nations, in the form of deceleration in overall economic growth and investor risk aversion leading to extreme stock market volatility and decreased corporate earnings.
Thankfully, some nations like Germany and France have been extremely resilient on the brink of an economic downturn in the distressed continent and have primarily saved the block from falling apart. However, this trait took a severe blow on the 19th of November as credit rating agency Moody’s Investor Services, downgraded the sovereign rating of one of the largest economies from the Eurozone—France (see Do Country ETFs Really Provide Diversification?).
The sovereign bond rating has been downgraded one notch from Aaa to Aa1 with a negative outlook. The primary reasons that have been cited by the agency for the downgrade are weak long term growth outlook, deteriorating fiscal condition and the lack of a Central Bank for monetization of its debts if the situation demanded.
The nation has been under tremendous pressure to bail out its counterparts, and now ironically, the fifth largest economy finds itself on the wrong side of things. This is the second rating downgrade for the French economy in Fiscal 2012 as rating agency Standard & Poor’s had earlier downgraded France to AA+ form its supreme AAA rating.
So what exactly does this mean for the U.S investors who wish to gain exposure in the slice of the market? Should they wait for a panic correction and then enter at cheaper valuations?
Or will there be no correction at all as the scope for an upside seems more than eminent? We seek to find these answers with the help of the only broad based pure play on the French economy—the iShares MSCI France ETF (EWQ).
EWQ tracks the MSCI France Index, which tracks the performance of the equity markets in France. It provides a proportionate exposure in every sector of the economy without being particularly biased towards any particular sector. However, Financials (15.80%) and Industrials (15.07%) are its top two sectors and these segments are highly correlated with the health of the broader economy (read 3 Sector ETFs with Solid Yields).
The rating downgrade is technically supposed to push borrowing costs higher especially for banks and other institutions if of course we see a rise in French Bond yields as well. Having said this, it is also prudent to note that the French 10 Year Bond Yield has risen by almost 11 basis points since the downgrade took place.
Although it’s difficult to exactly measure the impact of the rising yield on the corporate sector, one thing that remains certain is that it will surely hurt bigger and asset sensitive banks squeezing net interest margins. This is the only foreseeable disadvantage for the ETF a major portion of its asset is allocated towards the financial sector (see more in the Zacks ETF Center).
Barring this, there’s not much to worry about as far as the rating downgrade is considered. Of course the economy has its own set of problems as the corporate sector earnings have taken a plunge on account of the rising Euro which has led to the economy loosing its competitiveness in the global markets.
The ETF holds 74 securities in total with a concentrated exposure in the top 10 holdings with accounts for more than half of its total assets. The ETF was launched in March of 1996 and has been able to amass a modest asset base of $418.61 million. It charges investors a rather high expense ration of 52 basis points paying out 3.21% as yields.
From a performance perspective, the ETF has had mixed bag results just like most domestic equity ETFs. The following table summarizes its quarterly performance in this fiscal year.
EWQ Returns (Fiscal 2012)
Interestingly, in the 1st quarter, the ETF had performed best—the quarter in which it was downgraded by rating agency Standard & Poor’s. However strange it might seem, but the reality nevertheless. In fact the ETF is up by more than 13% in terms of year to date returns.
Also, defensive sectors like Consumer Discretionary (13.23%) and Healthcare (12.61%) account for a good proportion of EWQ’s total assets. This probably is an advantage for the ETF in times of market volatility (see Volatility ETFs: Three Factors Investors Must Know).
Also, from a risk analysis perspective, the ETF is relatively less volatile than other European funds having a three year annualized standard deviation of 32%. However, it does not provide international diversification as it has a strong R-Squared value of 80% against the S&P 500 Index.
EWQ is currently trading at $21.62 after the trading session on 21st November 2012. The 14 Day Relative Strength Index (:RSI) with a value of 45.55 is hovering around the neutral territory.
This is in alignment with out Zacks Rank of 3 or ‘Hold’ for EWQ. The RSI presently is in a recovery mode tending towards the overbought territory suggesting some upside might be left (read Zacks Buy Ranked Internet ETF: FDN).
The short term trend is definitely a positive one for EWQ. After a week of lackluster trading sessions on the week prior to the rating downgrade, the ETF has suddenly gained some momentum overtaking its 30 Day SMA line.
The breakout was characterized with an extremely strong volume of 530,000 shares compared to a three year average daily volume of 438,000 shares. The 30 day SMA currently stands at 21.48 while the 200 day SMA has a value of 20.65.
Whatever might be the situation, there is no denying the fact that France still is one of the stronger economies in the Eurozone with a relatively healthy balance sheet than most of its counterparts.
While France is still is not a complete avoid for investors at this point of time, and it remains one of the best ways to gain exposure in the continent, it is also true that if the situation in the surrounding nations does not improve substantially, things can go much worse from here, suggesting that investors should proceed with caution when dealing with the French ETF.
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