Three reasons why I’m buying Germany

Germany terrified Margaret Thatcher. She saw the 1990 reunification of East and West as a major threat to the rest of Europe. "We do not want a united Germany", you may remember her saying at the time. Mrs T wasn't known for beating about the bush!

Yet many, including the French, thought that the European project would bring Germany to heel or at least bring them onside.

Well, I guess we're about to find out. France's new president Franois Hollande has vowed to take on the German-led European machine. Out with austerity policies and in with pro-growth policies is his mantra.

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This looks like an epic battle brewing to me. And I know who my money's on...

I've always been a big fan of the German way' attention to detail, a strong work ethic and economic prudence. And though I love the French mode de vie', I've got to say I've always been sceptical of how it can stand up in an increasingly global and competitive world.

Now given this background, it strikes me as odd that the French and German stock markets are both valued equally. That is, they're both trading at around 12 times earnings. I think there's a profit opportunity here.

Today I want to show you three reasons why I'm adding to my German position, and how I think there's a profit to be made.

'This is for Germany!'

Having completed a degree in construction management in 1993, my first port of call was the biggest and busiest building site in the world - Berlin. Following the fall of the wall, the West Germans were rebuilding East Berlin in their own image - philosophically as well as physically.

Many said that the West Germans were mad. Their government was investing billions of Deutsche Marks in the dilapidated East and it was causing hardship in the West.

I remember a conversation I had at the time in a bar in central Berlin. It was after a few steins of lager and it was between us grads and a group of West Germans. It went something like this:

"Why are on earth are you shelling out your taxes on this grand charity case?" "Aren't you upset to see your wealth absorbed into this bottomless pit?"

The response was robust and unequivocal:"This isn't for us... this is for our children... our grandchildren. This is for Germany!"

It was a striking response. And it's stayed with me for all these years. It really goes to show the long-term vision that most Germans share. These guys weren't messing about.

Today Franois Hollande is expecting the same generosity of Germany. But this time he wants them to help the rest of Europe. He's calling for joint Eurobonds where basically the stronger nations of Europe subsidise the weaker.

And that's something that doesn't form part of the common vision of your average German.

I see three ways this could play out.

The scenarios

As far as The Right Side is concerned, the euro degeneration game is playing out pretty much as expected. Greece is looking increasingly towards the exit doors. The European banks are sinking into their sand-based foundations and a new set of European leaders are promoting nationalist policies.

So far, so bad.

Now I don't profess to know the precise end-game. But whatever happens, I'd say that Germany is likely to be alright...

Scenario 1: The euro region limps on... and on

It seems to me that the guys in charge are quite happy to allow the euro saga to limp on and on. One so-called solution' leads to a problem. Then another solution... another problem, etc, etc.

Over the last few weeks, the euro has performed pretty badly. And that could continue as this eurozone crisis goes on and on.

But a weak euro isn't actually that bad for Germany. It's an exporting nation after all, and a lower euro means lower export prices. Okay, so weakened European states aren't great for business. But on an inter-continental scale, Germany's export machine gets a boost.

Scenario 2. A euro break-up

The Greeks are already sidling up to the exit doors of the eurozone. In fact, shrewd investors are in the lifeboats... They've been withdrawing their cash from Greece for ages. In many ways, as far as many Greeks are concerned, Greece has already left the eurozone.

And once it's official (that is assuming Greece does exit), more countries could follow. I'm thinking of the southern European nations here.

Again, I don't see this as an intractable problem for Germany. Yes, its banks will suffer possibly very badly. Anyone holding bonds of nations exiting the euro are likely to lose pots of cash. But Germany's hardly going to be alone there.

And life will go on. Arguably, if the weaker nations drop out of the eurozone, then what's left are the stronger economies. And in that event, the euro should strengthen. That would be good news for holders of euro-denominated assets. German stocks (as measured in sterling) would receive a one-off boost.

Scenario 3. The euro stays together and strengthens

Yes, I know this looks highly implausible right now. I suspect scenario one or two to be more likely. But then again, you shouldn't rule anything out. Yes, things look grim in Europe; but then again, the situation is hardly hunky-dory in the rest of the Western world.

Maybe Europe, with Germany at its heart, will prosper. As I said at the outset, I like the German way' and if Germany can lead the rest of Europe in its ways, then there's a chance that the eurozone will prosper.

Personally I don't see it, but others I talk to do. And if they're right, then German stocks should perform well over the long-run.

Germany is worth a punt

I guess what I'm saying is that if you put your money down on the best horse, then it's more likely to do well whatever the conditions. And frankly I just can't see why French stocks should trade on the same multiple as German ones.

I could play a classic hedge fund strategy here. Short the French index and go long the German index. It's a classic pairs trade. And the beauty of it is that if the markets crash, then the French short should protect against losses on the German long position.

Ultimately to profit on this pairs trade, the German index needs to go up relative to the French index. And I've outlined my reasons why I think that will be the case.

To take advantage, placing a spread bet or contract for difference (CFD) would probably be the easiest way to do it.

As I write, my spread betting company is showing the French CAC 40 trading at 3,106 and the German DAX 30 trading at 6444.

If I buy the DAX at £1 per point, then effectively my exposure is £6,444 (simply multiply the stake by the value of the index)

So If I want to go short an equal value of the CAC, then I need to place a down-bet of £2.1 per point ie my short exposure is then £2.1 x 3106 = £6,522, which is near as damn-it equal and opposite to my long DAX.

For a full explanation on how spread betting works, click here.

And of course, all the normal caveats apply. Spread betting and CFD companies allow you to operate with considerable leverage, and that means you could lose more money than you put into the account.

And moreover, I could be wrong! Maybe, just maybe, Franois Hollande has something up his sleeve.

What do you think?

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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