Germany is the region’s second-largest economy and the world’s second-largest exporter. As a result, fears of a another global recession have weighed heavily on large-cap German stocks. France, the UK and Italy are among the country’s largest export partners, accounting for 10.1 percent of exports, 6.6 percent and 6.3 percent, respectively. Although the European economy has weakened, Italy is the only truly fiscally troubled nation of those three. Additionally, Germany enjoys deepening trade ties with a number of emerging-market nations; China accounts for 4.7 percent of Germany’s total exports. Emerging markets are expected to post robust gross domestic product (GDP) growth this year, which will provide strong support for orders of German manufactured goods.  

Germany’s export-oriented economy has generated strong growth compared to the European region. The country’s economy expanded at an annualized rate of 5.2 percent in the first quarter, far ahead of the 2 percent GDP growth that the region reported in the same period. Germany is one of the EU’s most fiscally conservative nations and has enjoyed the fruits of its export-driven economy. In May, the nation ran a current account surplus of EUR6.9 billion and its current account represented 5.7 percent of GDP in the fourth quarter.

Business sentiment in Germany also remains near the 10-year high set in February. Last month, the IFO Institute’s Business Confidence Index fell to 112.9 from 114.5 in June, signaling that manufacturers expect slower export growth in coming months. The index had climbed to 115.4 in February. However, most firms reported plans to hire additional workers.

Not all of the data is this positive; the ZEW Indicator of Economic Sentiment in July declined to a reading of negative 15.1. The ZEW Indicator of Economic Sentiment is a diffusion index–a  positive reading indicates favorable sentiment while a negative reading indicates weakening expectations for economic growth. Although the overwhelming majority of respondents rated the German economic situation as “good” in July, almost half expected inflation to rise in coming months. Almost three-quarters of respondents expected long-term interest rates to rise. Additionally, only 12.8 percent of those polled rated the economic situation in the eurozone as “good” and 60 percent expected little change to the region’s economic fortunes. Another quarter of respondents expected the eurozone’s economy to worsen in coming months.

It’s important to note that consumer spending accounts for a much lower percentage of economic activity in Germany than it does in the US. Despite the weakening economic sentiment, German retail sales surged 6.3 percent in June, following a 2.5 percent decline in May. The German consumer may be down, but they haven’t been knocked out.

One of the headwinds facing German markets is banks’ exposure to debt issued by Portugal, Ireland, Italy, Greece and Spain, the so-called PIIGS nations. According to data from the International Monetary Fund, international European banks in 2010 had $1.54 trillion in exposure to debt issued by PIIGS nations. Germany’s share of that total amounted to $522 billion, spread across the nation’s major institutions.

These exposure levels are a cause for concern. But a default in any individual PIIGS country wouldn’t bring Germany’s industrial economy to its knees. Although German industrials rely on bank lending for financing, they could certainly tap the capital markets for funds if necessary.

But the market has ignored these positive factors; the benchmark Deutsche Borse AG German Stock Index has plunged 13.1 percent this year. As of the time of writing, the index has also declined by almost 15 percent in August alone. While Europe’s economy faces daunting challenges, this sell-off has been wildly overdone.

IShares MSCI Germany Index (NYSE: EWG) tracks the country’s 50 largest companies, with 17 percent of the exchange-traded fund’s (ETF) investable assets allocated to four financial names. Of those four financial giants, only Deutsche Bank (NYSE: DB) has significant direct exposure to the European debt crisis.

The ETF has significant exposure to industrial outfits such as Siemens (Germany: SIE), which is heavily involved in the build-out of emerging-market infrastructure projects; BASF (Germany: BAS), a diversified chemicals outfit that produces its own oil and gas; and Daimler (Germany: DAI), the auto manufacturer whose venerable brands include Mercedes-Benz. In fact, those three companies account for almost a quarter of the fund’s portfolio. All three firms book extensive sales to emerging markets, which reduces their exposure to Germany’s domestic economy.  

The stable outlook for portfolio companies is reflected in the ETF’s forward price-to-earnings ratio of 11.2, compared to 13.5 for the S&P 500. With a modest expense ratio of 0.53 percent, iShares MSCI Germany Index is an inexpensive way to play the German market.

IShares MSCI Germany Index is a new addition to our Short-Term Opportunities Portfolio and a buy under 25.