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Is the France ETF in Trouble?

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The euro zone is experiencing the longest streak of recession in its 14-year history. While the crisis was initially contained in three of the troubled PIIGS – Portugal, Greece and Spain –the malaise is now spreading over to a number of other large markets, specifically France (read: Avoid These 3 Eurozone ETFs This Summer).

Inside the French Economy

The second largest economy of the euro zone appears to be in jeopardy and has shown resilience to the downturn since the fourth quarter of 2012. The reason behind the fallout is rising budget deficit, declining competitive edge and rigidities in labor markets. The budget deficit has widened to €31 billion as of March 2013, from €29.4 billion in the year-ago period.

The economy is struggling with deep structural issues such as a declining rate of productivity growth, low profit margins and deteriorating export performance that are affecting the growth potential in France.

Additionally, higher labor and production costs when compared to the competitive Asian and other European markets are pushing the French economy into another slump (read: Worried About Japan? Try This Top Ranked Asia ETF Instead).

Furthermore, a high unemployment rate and lackluster GDP growth remain matters of concern for the economy. In the first quarter of 2013, the economy entered into recession for the second time, contracting 0.2%. Unemployment still hovers around the 14-year high of 11%, more than double that of Germany’s 5.4% rate.

Given these weak fundamentals, the IMF now projects the French economy to contract 0.2% in 2013 compared to the previous forecast of a 0.1% decline. For 2014, the agency expects economy will grow by 0.8%, slightly below the previous forecast of 0.9%.

French President François Hollande is committed to introduce economic reforms that would lower labor cost, boost competitiveness and salvage the country from falling behind its neighbors. The IMF, however, feels that this would be a difficult task (read: Time to Sell the France ETF?).

Italy and Spain have made significant structural reforms in recent months, especially for their labor markets, to tackle the crisis. These reforms are expected to soon begin bearing fruit and put more pressure on France.

Bright Spot

French President François Hollande has begun to take steps that could eventually make the labor market more competitive. Additionally, the nation is trying to trim its budget gap from an expected 3.7% of GDP in 2013 to zero deficit by 2017 by squeezing public spending and bolstering competitiveness.

Though the current economic and political conditions in France appears depressing, the economy might turn around in the second half of the year if the expected reforms succeed in aiding economic growth (read: Three Country ETFs Struggling in 2013).

France ETF in Focus

Investors seeking to tap the opportunity from the current depressed economy have iShares MSCI France Index Fund (EWQ - Free Report) – the only pure option play targeting the country.

The ETF tracks the MSCI France Index, which measures the performance of the French equity market. With holdings of 71 securities, the product is moderately concentrated in the top 10 holdings with 50.6% allocation.

Among individual holdings, the pharma giant Sanofi, integrated oil and gas company Total SA, and banking firm BNP Paribus occupy the top three positions in the fund’s portfolio with 11.2%, 9.5% and 5.20% share, respectively. Among others, the fund does not invest more than 4% of the asset base in a single security.

The product is highly diversified across a variety of sectors. Industrials, financials, healthcare, consumer discretionary, consumer staples and energy make up for the double-digit allocation with less than 18% share each (read: Defensive Sector ETFs Leading the Market).

EWQ is relatively popular among investors, having amassed over $510 million in assets on average daily trading volume of more than 980,000 shares a day. The ETF charges a fee of 50 bps annually from its investors.

Looking at the fund’s performance, it seems that the fund was the least impacted by the downturn in the economy. Despite the gloomy conditions in the French economy, the product continued to perform remarkably well and posted a solid gain of 6.32% in the year-to-date timeframe and 41.52% in the trailing one-year period.

With these returns, the France ETF is leading the broader European funds significantly. The product has outperformed the most popular Vanguard FTSE Europe ETF (VGK - Free Report) , iShares MSCI EMU Index Fund (EZU - Free Report) , iShares MSCI Germany Index Fund (EWG), iShares MSCI Italy Index Fund (EWI) and iShares MSCI Spain Index Fund (EWP) by wide margins.

Bottom Line

Just remember that the overall outlook for France is still quite negative and that some more pain could be in store for this nation. This could be especially true if France’s economic and political issues spiral out of control, or if other problems turn up in the budget deficit control and the restoration of competitiveness, or if reforms do not help to alleviate economy from the downturn.

For this reason, the longer term outlook still isn’t very positive for EWQ. The country still has a host of problems and its fund is likely to have significant trouble (see more ETFs in the Zacks ETF Center).

As a result, in the long run, we are maintaining our Zacks ETF Rank of 4 or ‘Sell’ on EWQ. So, adventurous investors may want to consider nibbling on EWQ here, but those with an outlook of more than a few months should still shy away from this uncertain economy.

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