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Investing In France: Yes, You Can

Summary Growth is back in France. Why you should consider the country as an investing opportunity. The iShares MSCI France ETF will rise and shine next year. Investing In France: yes, you can. It has always been a fun – yet interesting – exercise to reflect on the cultural differences and similarities that existed between the foreign countries that I visited and my own. Long story short, I eventually realized (after living in the U.S. for a year) that despite the legendary French cynicism , I had every reason to be proud of being French. Once back in France, I became more and more aware of how my country was perceived by foreign investors and analysts. Economically speaking, France is seen as the laughing stock of the Eurozone, rather than a role model. Of course, if our social model allows our country to be more resilient in times of crises, it is also true that it slows down the economic recovery in times of global growth. But ever since François Hollande got elected, the French Bashing in financial literature has reached a level never seen before. Agreed, there are plenty of reasons to worry about France’s future: unemployment rate, fiscal policy, lack of support for entrepreneurs, lack of reforms, you name it. To add insult to the injury, we even have a socialist government! And yet, in May 2015 ” the French economy smashed expectations , expanding by 0.6% in the first quarter following zero growth in the previous quarter ” and in June, according to the Banque de France’s macroeconomic projections : ” after three years of virtually flat growth, French GDP will expand by an annual average of 1.2% in 2015, 1.8% in 2016 and 1.9% in 2017. ” The institution lists three different types of factors behind the recovery of the French economy: external (cheaper oil and a cheaper Euro), specific to the Eurozone (expansionary monetary policy), and domestic factors (improvement in corporate profit margins). ” On a domestic level, the measures introduced to cut labor costs should also start to support activity via gains in cost competitiveness which will in turn boost exports, job creations and business investment.” Indeed, despite Mr. Hollande being a socialist scarecrow, reforms (that were voted within the first years of its mandate) are starting prove themselves efficient. And several factors allow us to be more optimistic about the country’s future: Finance Minister, Emmanuel Macron is currently pushing a rather liberal agenda – that should help French companies during their journey through the infamous French fiscal maze. For instance, stores are now allowed to open 12 Sundays a year . It might seem insignificant, but it actually indicates that the government has decided to go against its left wing, even if it means discussing topics that had been considered ‘taboo’ until this day. Regional elections will take place in late 2015, and the socialist party is expected to be crushed by former President Nicolas Sarkozy’s brand new “Republicans”. Due to the nature of the election, the impact on French policies won’t be significant but it will send a positive signal to foreign investors. In 2016, regional reforms will be put in place and France will be the theater of a ‘regional big-bang’ that will see the creation of ‘super-regions’. If the process will need a few months (if not years) to be effective, the new regional entities will be amongst the most important within the European Union. For instance, the future Auvergne-Rhône-Alpes will rank 7th in ” Europe’s economic ranking “, and its capital Lyon will finally reach the critical size it needed to compete with other European metropolis. The easiest way to bet on France’s recovery would be to invest in the iShares MSCI France ETF (NYSEARCA: EWQ ) , the only U.S.-listed fund to be exclusively composed of French stocks. Next chart presents its top 10 holdings (they amount to 45.8% of the total holdings), with their respective weights in the total assets: As we can see in the following charts , its sector exposures differ than the CAC 40 (France’s top 40 stocks by market cap, balance sheet, liquidity…), the usual benchmark for the French stock market. iShares MSCI France ETF’s Sector Exposure (click to enlarge) The three main sectors represent around 15% each of the global holdings and are the following: Industrials, Consumer Cyclical and Financial Services. Their combined weight drive the ETF’s performance away from the CAC 40 as a whole: CAC 40 vs EWQ: One Year Return (click to enlarge) As we can see, the ETF consistently underperformed the CAC 40 over the past year, even sinking in the negatives when the CAC delivered a return of 8.8% over the same period. This can be explained by the fact that one of the fund’s top holding, TOTAL SA (NYSE: TOT ), has been heavily impacted by the fall in oil prices this past year. Still, when compared to the Crude Oil performance, Total isn’t doing so bad: Fortunately, SANOFI SA (NYSE: SNY ) and BNP PARIBAS SA ( OTCQX:BNPQY ), the other main holdings (with respectively 9.02% and 4.98% of Total Assets) saw their stock value rise this past year: SANOFI SA BNP PARIBAS SA The fund’s focus on Consumer Cyclical and Financial Services stocks reduced its performance as well, as the French economy was slowed down by higher tax rates (both personal and professional) and investors were reluctant to make significant moves due to the lack of political vision regarding the upcoming economic reforms. Nevertheless, one should keep in mind the bigger picture: over the past five years, we can see EWQ clearly outperforming the CAC 40. CAC 40 vs EWQ: Five Year Return (click to enlarge) At this point, one could legitimately question the opportunity of boarding a sinking ship. But I see this past year as a blessing for someone willing to invest in EWQ (obviously, EWQ holders might feel differently), as it is now quite inexpensive compared to the potential returns. Indeed, Consumer Cyclical and Financial Services stocks should thrive on the cost-cutting reforms that the Banque de France underlined, as well as on the expected GDP growth rates. We can also be optimistic about future reforms as the government recently operated a more liberal turn. Last but not least, the regional reforms will lead to bigger regions, and could strengthen the industrial firms as it will ease their clients and suppliers networks. EWQ: Two Year Return (click to enlarge) Currently ( data obtained on June 06, 2015; via YAHOO Finance) at 26.70, the ETF is 4 dollars cheaper than last year’s high of 30.73, and as a result it becomes very affordable to invest in. As previously explained in this article, EWQ is bound to rise in the upcoming year. Last but not least: even if it is easy to make fun of France’s bureaucracy, or of its overall business environment, it would be a strategic mistake to disregard all investing opportunities. In case of a crisis in the Eurozone (think about Greece), France (along with Germany) will remain a safe heaven, as the 2nd strongest economy of the EU. It happened not too long ago, and an early taste of French markets could come handy in uncertain times. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

European QE: Implications And Investment Opportunities

Summary The European QE, while beneficial, will have different impact and consequences than the US and the UK style QE. The retail European market is not as well developed as in the US, UK so the main risk asset likely to benefit from a large QE will be real estate. Countries with largest equity markets to GDP like the Netherlands, Belgium, France and Spain will benefit disproportionately from a risk on equity trade. Difference between European QE and US and UK style QE The European QE announced by ECB last week consists of a monthly Euros 60 bn private and public bond buying that will last until at least September 2016. The euro denominated debt purchases will be all along the yield curve between 2 and 30 years maturities and will represent no more than 25% of each issue. The debt purchases will be mutualised, sharing the loss up to 20% and the rest of 80% will stay with the national central banks. Interestingly, the government debt to be acquired by ECB is investment grade only so Greece and Cyprus debt will likely not be considered for this QE round. While both the Fed and the BoE bought back government debt, so in nature the style of the ECB QE is similar, the lack of debt mutualisation across the Euro zone will skew the benefits towards the countries with best fundamentals in 2016 when the QE starts to slow down. In addition, the funding transmission mechanism in the Euro zone does not work quite the same as in the US or in the UK. Lower rates across the euro zone should lower rates for corporates and individuals but we may not see the impact of these rates in the short term and uniformly across the Euro countries. Euro corporates use far less bond debt than the UK Plc or the US corporates. Even though the European bond market has seen significant growth after the 2009 financial crisis, the majority of the corporate debt, especially for the long term maturities and for the small and medium sized companies, is still bank debt which will be slow to adjust to market yields. The positive and perhaps intended long term consequence here is that it may encourage SMEs to increase financing with corporate bonds issuances in the eurobond market, just like it did after 2009 when bank liquidity dried up. So in the medium and longer term – this is some of the SMEs in Spain and Italy and other non-core Euro markets where the bank lending rates are at 4-6% (Reuters). Most of the immediate positive impact however will be on the larger Eurozone corporates from Germany, France, Spain and the Netherlands (that operate mainly within the Eurozone and as such don’t have a negative currency impact on their revenues) and who can improve their average debt rate substantially. Eurozone mortgages are by and large fixed mortgages from 1 to 5 years and longer and refinancing for these mortgages is not straightforward. While the proportion of variable rate mortgages has increased since 2009, the fixed rate mortgages are still predominant in France, Italy, the Netherlands and Germany, so it will take some time for the wealth effect from lower mortgages and refinancing to have an impact on the consumers in these markets. On the other hand, countries like Spain and Ireland, where most mortgages are based on variable rates may benefit most on short term. Investment Implications As yields are going down, institutional and individual investors are likely to chase higher yield assets like equities, high yield bonds and alternative assets like real estate and private equity: Equity markets in the Eurozone are not as developed as in the UK or the US relative to the size of their GDP. As the chart below shows, the ratio of the equity market to GDP in some European countries like Germany at 54% or Italy at 15% is incredibly low when compared to the UK or the US. Countries with the most developed equity markets, like the Netherlands (NYSEARCA: EWN ), Belgium (NYSEARCA: EWK ), France (NYSEARCA: EWQ ) and Spain (NYSEARCA: EWP ) will likely benefit most from a risk on equity trade. (click to enlarge) Source: Gurufocus, ECB, Reuters Low rates will benefit new investment in real estate and we are likely to see real estate prices going even further up especially in countries where equity markets are not very popular and in countries with mostly variable mortgage rates. Despite a strong performance in the past year, German REITs like Deutsche Wohnen ( OTC:DWHHF ) and Deutsche Annington ( OTC:DAIMF ) are still the best positioned to take advantage of a rising real estate market. Some Spanish real estate developers like Immobiliaria Colonial [COL.SM] may also be an interesting though volatile play. (click to enlarge) Source: Bloomberg Lower Euro will likely bring significant positive changes, even though some economists don’t think so as too many of the goods produced by the euro companies are outside of the Eurozone territory. The services sector, especially the travel and leisure sector including companies like TUI AG, is a clear winner from a lower currency. The SMEs and the corporates with competitive manufacturing bases in the Eurozone exporting outside of the area will also benefit. A lower exchange rate for the Euro will further support the exporters, especially the largest two exporters in the Eurozone who are also highly competitive manufacturers: mostly Germany (which according to WTEx, produced about 29% of the European exports in 2013 and has a large SME sector) and to a lesser extent the Netherlands (with about 9-10% of the European exports in 2013 but a smaller SME sector). In Italy only, the estimated boost to GDP from a lower currency is about 0.6% per year ( CSC, Il Sole 24) While the QE benefits will be widely spread and may give a fresh respite to countries like Italy and France, somewhat ironically the largest positive impact will benefit the countries that have fought it mostly. The Dutch and to a lesser extent the Belgian equity markets and real estate sectors in countries like Germany and Spain will likely be the big winners. Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in EWN over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Editor’s Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks. Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in EWN over the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.