Investors have grown increasingly disenchanted with Europe over the past two years as the continent’s sovereign debt crisis—which began in the EU’s peripheral economies—now threatens to spread to the region’s core. Consequently, investor sentiment regarding even Europe’s strongest economies has soured.

Germany is the region’s largest economy and the world’s second-largest exporter, and fears of another global recession have weighed heavily on large-cap German stocks. France, the UK and Italy are among the country’s largest export partners, and any significant slowdown in any of those countries can adversely impact Germany. However, Germany enjoys deepening trade ties with a number of emerging-market nations; China takes in 4.7 percent of Germany’s total exports. Emerging markets are expected to post robust gross domestic product (GDP) growth this year.  

Germany’s export-oriented economy has generated strong growth compared to the European region. Although GDP growth fell to 0.1 percent in the second quarter, 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 countries; 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. In August, the IFO Institute’s Business Confidence Index fell to 108.7 from 112.9 July, marking the index’s second monthly decline and signaling that manufacturers expect slower export growth in coming months. The media has reported extensively on this declining sentiment. But business confidence in Germany remains strong and most firms plan to hire additional workers.

Not all of the data is positive; the ZEW Indicator of Economic Sentiment declined to a reading of negative 37.6 in August from negative 15.1 in July. A positive reading indicates favorable sentiment. Although the overwhelming majority of respondents rated the German economic situation as “good” in August, almost half expected inflation to rise in coming months. Almost three-quarters of respondents expected long-term interest rates to rise. Most respondents cited the prospect of a US recession as a major factor in their negative outlook.

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.

Nevertheless, the market has ignored these positive factors; the benchmark Deutsche Borse AG German Stock Index has plunged by around 20 percent this year—declining by more than 15 percent in August alone. Although 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.