Germany Is The Best Way To Play Europe

Germany is the biggest economy in Europe and the world's fourth-largest, has an AAA rating from S&P and is the major partner in the solution to the Eurozone sovereign debt crisis. Politically, Germany has increased a lot its power during the last two years and, nowadays, nothing happens in the European Union without the German support.

Even the debt crisis has been beneficial for Germany, with its debt yields falling to record low levels. The budget shortfall plunged to 1% in 2011, well below the 3% limit imposed by the Maastricht Treaty.

Macroeconomic Background

Its economy has also shown its greater dynamic in Europe, recovering more quickly than other European countries from the financial crisis of 2008-09. The GDP growth recovered strongly after 2009, with a 3.7% growth rate in 2010 and 3% in 2011. This result is much better than of the Eurozone, which grew by 1.9% in 2010 and 1.5% in 2011. For 2012, the latest forecasts from the European Commission said on 23 February that the euro-region economy may contract 0.3% this year, while German GDP is seen rising 0.6% in 2012.

The unemployment rate in Germany has reflected the strong economic performance, falling gradually in recent years reaching new lows since the reunification of Germany (beginning of the '90s). Germany's unemployment held at the lowest in more than two decades in February, with a 6.8% rate. This is the lowest unemployment rate since 1992 and the opposite reality from southern peripheral countries, which are registering new record highs.

For example, Spain has an unemployment rate above 20% and Greece is rapidly approaching this level. In Portugal, the unemployment rate was almost 15%. In all Eurozone countries together, the unemployment rate (10.7%) reached a new high since 1999 in February.

Exports - Driven Economy

Germany is clearly a globalization winner being the world's second largest exporter after China, which has only surpassed Germany in 2009. Exports account for more than one-third of German GDP. In 2011, businesses exported goods to the tune of €1.06 trillion ($1.405 trillion), breaking the trillion-euro mark for the first time.

Currently, almost 30% of German exports go to emerging markets, including the BRIC countries, while the share going to develop countries has fallen slightly in significance. For example, German exports to the BRIC countries are already almost twice the exports to the US. The share of exports to the US has fallen considerably over the last 10 years, accounting for only 6.9% in 2010 from 10.3% in 2000.

Germany is also the world leader in mechanical engineering, holding about 20% of this global market. Core German exports include such engineering products as vehicles, machinery, chemical goods, electronics, shipbuilding and optics. German brands including Mercedes-Benz of Daimler Group (DDAIF.PK), BMW (BAMXY.PK), SAP (SAP), Siemens (SI), Volkswagen (VLKAF.PK), Adidas (ADDDF.PK) and Porsche (POAHF.PK) are among the highest-valued in the world.

Also key to Germany's success in international trade is the fact that "Made in Germany" is a global seal of quality. In the minds of trade partners, German products are synonymous with quality, innovation and cutting-edge technology.

German Equities

Benefiting from this export-driven economy, companies in the German principal index DAX 30 generate, on average, 70% of their revenues abroad. Although Germany isn't completely immune from weakness of its neighbors', for instance the top destination for German exports in 2011 was France, the German economy has proven to be much more resilient than other European countries.

This factor bodes well for its companies that are making new high record profits. The DAX Index is up 17% Year to Date YTD, but over the last 12 months the index is down 4%. This return is better than the Dow Jones Eurostoxx 50 Index with a 10% YTD return and -9.87% in the last year.

Source: Yahoo Finance.

In terms of valuation, the dividend yield of the DAX 30 is around 3.6%. This value compares favorably with the yields on the principal US benchmarks. S&P 500 (IVV) have a 2% yield and even mid caps benchmark Russel 2000 with a 1.49% yield, is well below the German yield. The German equities trade with a P/E of 12.1x, compared to 13x for the Eurostoxx 50 Index and 14x of the S&P 500.

Conclusion

Given that the German economy is exposed to global growth, there does not seem to be a threat of recession for 2012 as opposed to Europe as a whole. What is more likely is a slowdown in growth, also supported by the solid labor market that should keep private demand strong.

Because of its cyclical nature, the German equity market is profiting strongly from its exports to emerging markets. The high yield and undemanding multiples are also supportive for German equities and support the view of undervaluation of the German market. This view can be played through an ETF like the iShares MSCI Germany (EWG).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.