Europe ETFs Pause, but Upside Remains

Diversified Europe exchange traded funds are taking breathers even as U.S. stocks ascend to new highs. For example, the Vanguard FTSE Europe ETF (NYSEArca: VGK) is off nearly 3% in the past month while the S&P 500 is higher by 1% over the same time.

Do not blame the recent retrenchment in Europe ETFs entirely on downtrodden emerging markets. VGK’s one-month loss is nearly triple that of the iShares MSCI Emerging Markets ETF (NYSEArca: EEM). Investors are still believers in the Europe recovery story, indicating the recent pullback could be a buying opportunity.

For example, VGK and the iShares MSCI EMU ETF (NYSEArca: EZU) are two of the top ETFs in terms of 2014 inflows. That shows investors’ preference for broad exposure to Europe via ETFs is, well, broad. Broad because VGK is heavy on non-Eurozone members the U.K. and Switzerland while EZU is comprised only of countries that use the common currency. [Europe ETFs See Big Inflows]

The good news is European stocks were not expensive relative to their U.S. counterparts before their run higher and European shares still trade at discounts to U.S. peers.

“As previously mentioned, we think Eurozone equities are inexpensive right now. If you look at the price to book ratio of the Eurozone versus the U.S. compared to the long term average, you can see there is much value to be had overseas,” said BlackRock Head of International Product Management Dodd Kittsley in a recent note.

Within European equity markets, steadier hands such as the U.K., Switzerland and Germany, the Eurozone’s largest economy, look pricy compared to peripheral European markets, but that is the price to be paid for reducing perceived risk. [A Preference for Germany ETFs]

European small-caps still offer something of a value proposition as the group looks to restore earnings growth that still remains far below that of a previous peaks. Investors are betting on that recovery as evidenced by sentiment toward the WisdomTree Europe SmallCap Dividend Fund (NYSEArca: DFE). Not only was DFE the best-performing Europe ETF in 2013, the ETF is up another 7.2% this year and recently crossed the $1 billion in assets under management mark. [Small-Cap ETFs for European Growth]

Many analysts predict that the European profit cycle still has room to expand, with European indices focused on small-caps still posting earnings about 60% below previous peaks, according to WisdomTree research.