Authors: Alan Gutman, Lorenzo Di Sarro, Andrew Qiao, and Jerry Yuan
Summary:
- To best capture future European growth and to have some exposure to non-US assets in a balanced portfolio, TenjinAi recommends the following ETFs which scored very highly in its proprietary AI-based rankings: DAX (Global X DAX Germany), EWN (iShares MSCI Netherlands), and FEZ (the SPDR Euro Stoxx 50 ETF).
- The failure of the U.S.-China Phase I deal and the follow-through with Phase II will ultimately determine the future investment climate in China.
- After being hit the hardest by the Coronavirus pandemic, the European Union is expected to have a large economic recovery in 2021 and 2022.
- The allocation of funds from the €1.8 trillion EU Expenditure Plan in sectors such as technology and energy will determine the influence of the investment viabilities in European countries.
- The inflationary breakdown and the rising German Bund yield reflect positively on the Eurozone’s economic health.
Uncertainties Ahead in the Chinese Investment Climate:
Phase I of the U.S.-China trade deal was signed on January 15, 2020, and officially started in February of 2020. The deal focused on these four important components:
- Protecting American and foreign intellectual property
- Increasing Chinese imports of U.S. agricultural, manufacturing, and energy goods
- Easing of investment restrictions into China
- Expanding trade commitments between the two countries
In total, the imports section of the agreement focused on adding around $200 billion of U.S. imports to China by the end of 2021. Most notably, the imports section of the agreement sought to increase Chinese purchases of American agricultural products up to $40 billion in 2020 and 2021. This would mark the largest purchase of this type in U.S.-China trade history, as illustrated below.
However, since then, the Coronavirus pandemic has hindered China’s ability to uphold these import agreements. China had only purchased around 60% of the agreed-upon U.S. imports in 2020. Along with the pandemic, the recent trade war with China is also thought to have impacted China’s willingness to follow through with these commitments. This can be illustrated through China upholding its commitments with trade agreements with the European Union, despite the Coronavirus pandemic.
In April of 2021, the U.S. government issued a statement claiming that despite the new updates in Chinese patent law, Chinese commitments to protecting American and foreign intellectual property rights have not been adequately met. This adds to the dubiousness of China’s intentions to follow through with Phase I and goes onto Phase II of the trade agreement.
While still in consideration by both countries, Phase II of the deal still seems far away. This stage plans to cover contentious issues including state-sponsored cyber-crimes and revisiting intellectual property rights in a stricter manner. This could encounter unforeseen difficulties in the negotiation process between the two counties given the failure of China on many aspects of Phase I of the deal.
The perceived follow-through with Phase II between the U.S. and China shows that there is a much larger share of risk than return in the event that both nations can come to an agreement. At this time, both the U.S. and China still contend that Phase II is a possibility; however, the likelihood of it is unknown. At this time, other markets, especially the European region, remain a better investment decision.
Europe on Track to Become the Best Global Investment Destination:
Multiannual Financial Framework
Over the next six years, the European Union plans to invest over €1.8 trillion into nine broad areas of the economy with the goal to jump-start the EU economy and recover from the effect of the COVID-19 pandemic. The Multiannual Financial Framework aims to accomplish the EU’s green and digital initiatives by investing over €517.3 billion into sectors such as technology, agriculture, and energy.
In previous EU budget plans, strategic investments provided renewable energy to 10 million households and high-speed internet to 15 million homes. These supporting investments will continue within the 2021–2027 budget plans through the help of InvestEU, which is centered around boosting public and private investment in sustainability, innovation, and job creation. Within the MFF budget plan, InvestEU will contribute €372 billion over six years with its main focus being sustainable infrastructure and the push towards renewable energy.
Inflation
Any large inflow of money into an economy, such as the €1.8 trillion from the EU Recovery Fund that will be spread across its member countries, can cause inflation. Much of the fund is being paid with joint EU bonds, essentially mutualizing the debt between many of the member countries. Doing so limits the inflation risks in individual nations and drives the overall risk lower.
Much of the inflationary pressure on the EU has come from the ongoing recovery and reopening of its economies. As pandemic-related restrictions have been easing, people have begun buying more consumer goods, including energy-related items such as gas to fill up their cars for travel. The European Commission currently forecasts a large spike in the first two quarters of 2021 as reopening continues, averaging out at 1.9% for the year. The Commission also predicts most of the recovery to have occurred in 2021, leaving a lowered inflation rate of 1.5% for 2022. The graph below shows the Commission’s split between a few individual components.
GDP Growth and Economic Boom
Throughout the COVID-19 pandemic, the EU saw a 6.1% decrease in total GDP and experienced an unemployment rate of 7.6% at its peak. Looking forward to the EU economy reopening and significant progress with vaccination rollouts, the EU is starting to show signs of recovery and momentum. According to the European Economic Forecast, GDP is expected to grow by 4.1% in 2022 and then strengthen by 4.4% in 2023. These forecasts are attributed to the “stronger-than-previously expected to rebound in global activity” followed by the Next Generation EU (NGEU) Recovery plan that will continue until 2023 and will then merge with the EU 2021–2027 budget plans. Private consumption is expected to grow with the effect of a decline in household savings rates, dropping from 19.4% in 2021 to 13.6% in 2022. Overall the EU economy is expected to rebound from the downturns brought by the COVID-19 pandemic, while also continuing to grow with the help of NGEU and other pro-business policies that are starting to shape the EU into an attractive investment opportunity.
Nord Stream 2
With U.S sanctions failing to interrupt the progress of Nord Stream 2, the 764-mile twin pipeline is expected to be completed by the end of this year according to Russian deputy prime minister, Alexander Novak. The Nord Stream 2 pipeline aims to meet the demands of gas production within the European Union which had previously failed to establish a reliable and sustainable gas supply. The EU gas market is already a well-connected sector that will utilize Nord Stream 2 to increase liquidity and overall competitiveness for gas prices. In parts of Eastern Europe, new infrastructure has been deployed that will help improve the supply situation and will increase access to Western European gas hubs. This expansion will also help Non-EU countries such as Switzerland and Ukraine supply their gas demand directly through the EU. Germany was the overall winner from the construction of Nord Stream 2, with the project adding over €1.85 billion to total GDP and housing the largest number of jobs created from the inception of the pipeline project.
All Eyes on Germany
With Germany being the strongest economy in the European Union, the country still suffered a 5% decrease in total GDP followed by a 6% drop in private consumption. But just as with other EU countries, there is forecasted growth that relies heavily on the unprecedented 6-year budgets that aim to reboot and restore EU member economies. For Germany, real GDP (yoy%) is forecasted to grow by 3.4% in 2021, 4.2% in 2022, and 1.9% in 2023. Other promising forecasts show a 19% jump in exports over the next three years and a recovering CPI that is expected to return to its below 2% goal by 2023 (1.7%). Along with the completion of the Nord Stream 2 pipeline and its positive economic output, Germany is poised for growth and expansion that will be accompanied by economies fully reopening in both the EU and globally, allowing for trade to recover.
Adding to the case of German economic recovery and growth, the German Bund (similar in nature to the U.S. Treasury Bond) is on track to reemerge from negative yields. The German 10yr bond plunged below 0% in March 2019 and plummeted to an all-time low of -0.90% in March 2020 due to Coronavirus fears and shutdowns. Yields have trended consistently upwards since the start of 2021 and are currently trading at around -0.18%. Rising German Bund yields signify that investors are gaining confidence in the German economy, signifying that investments in the country are becoming increasingly attractive.
Where Should You Invest?
DAX — Global X DAX Germany ETF (Tenjin score 4.74/5) includes ten sectors and holds the 30 largest German equities by market cap. Some of the major holdings include SAP, Adidas, Infineon Technologies, and Allianz. The DAX ETF also holds a 5% position in Deutsche Telekom, which aims to bring fiber optics to all German households by 2030 alongside the help of EU digital incentive funds. Whether it be the forecasted GDP growth or the economic benefits that will stem from the completion of Nord Stream 2, the German economy is in an excellent position for not only a strong economic rebound but also quality growth throughout many sectors of the economy.
The Netherlands is on the path to quality growth
The Netherlands’ total GDP is expected to rise by around 6% by the end of 2022. This forecasted growth will place the Netherlands' real GDP at 2.3% above pre-pandemic levels. The Dutch Economy is also expecting to grow in private consumption by 1% in 2021, followed by a massive 6.5% leap leading into 2022. Like Germany, the Netherlands has committed a large portion of the funds and labor needed to complete the Nord Stream 2 pipeline. These contributions have added €1,051 million to total GDP and have created 11,990 FTEs over the past five years since December of 2018. The Dutch economy is also on track to see continued growth within its strong tech space. With new digital initiative funds, the growth of the tech-savvy economy will continue to be an attractive location for tech-related foreign investments.
Capture the Dutch Economy
To capture this forecast growth, EWN — the iShares MSCI Netherlands Index (Tenjin Score 4.96/5) is currently the only ETF that is able to invest in the entire Dutch market. The portfolio breakdown is concentrated mainly on Dutch technology companies, which is an advantage when looking at the numerous R&D incentives that have shaped the Netherlands into a tech-savvy country with a strong digital infrastructure that continues to grow the tech community. The Netherlands has been categorized as a “Strong Innovator” according to the European Innovation Scoreboard (EIS) as it maintains one of the highest “Use of Information Technologies” scores in all of Europe. This ranking is significant as the “information technologies” sector accounts for over 32% of the entire Netherlands EWN ETF.
France’s Economic Rebound
After a historic drop in France’s GDP by -8.1%, the country is on track for a healthy recovery. GDP is expected to rise by 5.7% and 4.2% in 2021 and 2022, reflectively. France is set on reopening a bit slower than other EU countries in order to keep growth momentum in check. Furthermore, a good sign for future growth is reflected in the lowered savings rates, which are anticipated to a pre-pandemic level of 14.6%. This signifies the public’s renewed confidence and will reflect in future spending on consumer discretionary goods. Having this outlook on France’s economic health is important, as it comprises a large portion of the next recommended ETF.
Increase Exposure Across the Eurozone
The FEZ — SPDR Euro Stoxx 50 ETF (Tenjin Score 4.93/5) follows the Euro Stoxx 50 Index, capturing Europe’s 50 largest stocks. The countries reflected in the ETF focus heavily on France, Germany, and the Netherlands. Looking at the breakdown of the sectors, the most heavily weighted ones include consumer discretionary, information technology, industrials, and financials. Investing in this ETF benefits from being able to reflect the European market quite effectively, as the weights of the stocks follow their market capitalizations. This helps achieve a 95% free-float market capitalization of the Eurozone countries in the ETF.
The reopening of these countries, coupled with the EU’s Recovery Fund, sees direct benefits in the most heavily weighted sectors of this fund. The SPDR Euro Stoxx 50 ETF is also attractive on a gross expense basis, where its ratio is 0.29% compared to the average European ETF’s ratio of 0.55%.
† Tenjin scores refer to Tenjin AI Financial Technologies’ proprietary AI-based model that scores and ranks various high-quality ETFs and Stocks from a multitude of factors on a weekly basis.
