There has been a tendency to lump together the whole of the European continent and predict worst-case scenarios in the aftermath of the war in Ukraine, rising fuel prices and the fall of the euro following the review of the monetary policy of the ECB. With so much negativity in the price, the Vanguard FTSE Europe ETF (NYSEARCA:VGK) is now available for less than $51, after suffering a nearly 27% year-over-year decline, as seen in the chart below.
However, Europe is made up of many countries and regions that have been impacted differently by supply chains and high commodity prices, and this thesis attempts to look beyond the gloom to identify opportunities, while highlighting the risks.
I begin by providing an overview of country exposure.
Diversification at national level
As shown in the table below, in addition to the UK, France and Germany, VGK owns shares of companies located in many other countries such as Austria, Belgium, Denmark, Finland, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain and Sweden. Interestingly, 15.2% of its assets are dedicated to Switzerland, which includes pharmaceutical companies and financial institutions.
This diversified country-level exposure is in itself diversification and includes a range of value opportunities that fly under the radar as many holdings are currently trading at low prices. This contrasts with the United States, where opportunities are limited as valuations remain above historical averages despite recent stock market declines.
Additionally, despite the majority of countries suffering globally, VGK in blue underperforms both the S&P 500 (in orange) and the Vanguard FTSE All-World ex-US ETF (VEU) in purple . So, from a valuation perspective alone, Europe is far from being a super bubble.
This undervaluation is not normal because despite an unprecedented energy crisis which risks causing a rationing of natural gas for its industries, Europe has some of the most competitive multinationals in the world which can relocate their production to other countries where they operate.
Additionally, VGK seeks to track the performance of the FTSE Developed Europe All Cap Index. However, it is developed markets, and not underdeveloped or developing countries, whose economies must be rescued at the first signs of deterioration in the balance of payments or acute currency devaluations. To this end, many European states have developed the resilience of their economic models, in particular through elaborate social protection systems financed by taxpayers’ money.
Thus, there may be a cap on the energy price spike with higher taxation for oil companies to finance widening national trade deficits. For this question, the Vanguard ETF only has 5.76% exposure to energy companies. In addition, the sharp rise in interest rates by the ECB (European Central Bank) or the Bank of England may lead to economic slowdowns, but this does not mean that there will be a crisis of apocalyptic dimensions, which would suddenly blow up VGK’s holdings. existence.
Participations – Strengths and Weaknesses
As investors will notice, the top ten holdings out of a total of 1,369 are not from Germany or Italy, whose economies have a higher mix of industrialists who are expected to be hit hardest by the rising cost of electricity. ‘energy. Normally, when you think of Germany, you automatically associate the country with car manufacturers.
Well, VGK does not include any of these major German automakers in its top twenty holdings but, on the other hand, owns shares of SAP SE (SAP) as shown above. After some short-term headwinds from its exposure to Russia, this German enterprise software and cloud game should see more sales as its US competitors’ products become more expensive in Europe and other parts of the world. world due to a strong dollar. Along the same lines, VGK includes other companies that stand to benefit from windfall gains in FX, even if a falling Euro or British Pound is bad for inflation.
The ETF also includes the giant Allianz (OTCPK:ALIZF), as well as other insurance companies, such as Zurich Insurance (OTCQX:ZURVY) which are considered to be the beneficiaries of the policy of raising interest rates of the ECB. The reason for this is that in addition to investing, insurance companies also hold policyholders’ money in banks and when interest rates rise, the value of their assets also rises. In fact, the fund devotes around 15% of its assets to financials, including banks like HSBC plc (OTCPK: HBCYF).
Additionally, a sector seen as defensive in tough times is healthcare, which makes up around 15% of VGK’s assets, including big names like Swiss-based Roche AG (OTCQX: RHHBY) and Novartis (NVS). As evidenced by the one-month stock market performance of these two companies, the healthcare sector held up well.
By contrast, the consumer discretionary sector represented here by luxury brand LVMH Moët Hennessy (LVMH) has suffered 9% over the past month, despite revenues up 13% in the second quarter of 2022 year-on-year. . base. There was, however, a slight decline on a sequential basis, instilling doubts in the minds of investors as to whether there might be further difficulties in the second half of the year.
Remaining cautious, industrial operations which constitute 15% of VGK’s total assets are likely to suffer the most, as in addition to suffering from rising energy and material costs, they are likely to face prospects of uncertain demand. This uncertainty appears to have been priced into the 40% decline in Siemens (OTCPK:SIEGY) since the start of 2022.
Yet Europe’s largest manufacturing company has yet to capitulate and recently commissioned one of the largest green hydrogen production plants in Germany. In a way, this shows Europe’s commitment to green technologies while the United States is stuck with its oil companies. So Europe is better prepared for global warming while across the Atlantic Ocean many are choosing to keep their heads buried in the sand. This implies that there is a risk that the US federal government will not have enough money to bail out flooded areas or places ravaged by major fires or hurricanes.
However, the future remains uncertain, not only on the old continent but almost everywhere in the world, including in the United States where confidence has now given way to doubt since the Fed must now apply the most drastic after a rise in the CPI. (consumer price index).
Under these circumstances, Europe deserves a fresh look, and peering into the price action, VGK hit a low of $49.97 on the first day of September, coinciding with the Russian cut and the no – resumption of natural gas supplies to Germany. It is currently trading at $50.25 and tested the $50.50 level on July 14. Therefore, $50.25-50.50 appears to be a resistance level.
Also, when the ECB raised rates by 75 basis points, VGK then rose about $2 to $53.51, showing that investors appreciate the fact that the ECB is willing to do what it takes to fight inflation. Additionally, many companies that have cash are fighting back with commodity hedging like Volkswagen (OTCPK:VWAGY) which gained €400m this way.
Therefore, if one sticks to the rhetoric of diversification, not all holding companies are likely to experience the same level of headwinds, namely those based in France. This country is in a unique situation because it was not as dependent on Russian oil as Germany due to the increased number of nuclear power plants and engineers are working very hard to repair older ones before winter. It is therefore much less vulnerable to the war in Ukraine.
Conclude with the justification of the dividend
Therefore, all is not bleak and there are many “pockets of opportunity”. For those who have been long in cash and want to diversify into an income-generating ETF, VGK pays one of the highest yields (at 4.38%) as shown in the chart below.
Now, one of the reasons yields are so high is VGK’s loss of value. Additionally, the chart above shows that quarterly dividend payouts are not uniform. The reason for this is that, unlike some US counterparts, European companies do not intend to become dividend aristocrats. Instead, when the business is not doing well, they cut the dividend and when conditions improve, they increase the returns. This is why a high dividend does not mean that their business is underwater and they are desperately trying to create a value trap. So the higher dividend payout in July shows that the underlying fund is doing well.
As an alternative to VGK and for those (like me) whose brokers give them access to funds listed in Europe, there is the Lyxor CAC 40 (DR) UCITS ETF for French stocks, the Xtrackers XDAX INCOME ETF for Germany and the Lyxor Core UK EQ ALL CAP DR ETF which provides access to many of the holdings I mentioned above. They also pay good dividends. However, the Vanguard ETF remains cheaper with an expense ratio of just 0.08% and you get all stocks in one basket.
Finally, the Ukraine conflict and high commodity prices all have the hallmarks of a “predictable recession” where investors, as well as the common people, already know in advance many of the pains to come. Therefore, while there may be a further drop in VGK in the event of a “winter recession” in Germany or further difficulties in the UK as the value of the pound declines, I do not foresee a stock market crash of the proportions apocalyptic as is the case during a normal recession.