Europe-related exchange traded funds have largely underperformed U.S. markets for many years, but things are finally turning around as European equities begin to pull ahead this year.
“After underperforming US equities for the better part of this decade, Europe has rebounded strongly in 2017. Many investors with a ‘once bitten, twice shy’ mentality to international investing may have missed the story underpinning this outperformance,” BlackRock strategists said in a note.
After European exchange traded products experienced $34 billion in outflows over 2016%, the ETPs have attracted $20 billion in inflows globally this year, reflecting the growing interest for Europe-related assets on increased concerns over valuations in domestic U.S. markets.
According to BlackRock, there are three reasons that continue to support the ongoing momentum in European markets, including global reflation, stronger earnings and attractive valuations.
“Reflation is going global; we see particular benefits for Eurozone stocks,” BlackRock said.
Germany and France, which account for half of Euro area GDP, is expected to surprise on the upside as growth picks up speed. Moreover, the lessening political risk in Europe, leading indicators like purchasing manager index, demand for loans and sentiment surveys all suggest that the market continues to improve. BlackRock also pointed out that Eurozone stocks are particularly sensitive to changes in GDP and the ongoing global growth story could disproportionately support this region.
“Earnings surprises are part of a longer-term trend,” according to BlackRock.
The ratio of Eurozone earnings upgrades relative to downgrades is at its highest level since 2010, with net upgrades still rising, reflecting the best Eurozone earnings season for beats in seven years. Looking ahead, profitability estimates for European corporations have been improving since the summer of 2016 but remain below 50% their peak pre-crisis levels, which suggests there is more room to run.
“Valuations are attractive after years of underperformance,” BlackRock added.
Europe valuations remain attractive relative to historical levels. The MSCI Eurozone is only hovering around the 66th percentile of its historical valuation with forward P/E levels 11% below their 2015 peak. Additionally, Europe is also trading at a 16% discount to the S&P 500 and a 7% discount to the MSCI ACWI when looking at the forward P/E.
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ETF investors interested in gaining exposure to Eurozone countries may consider something like the iShares MSCI EMU ETF (NYSEArca:EZU). EZU tracks the MSCI European Monetary Union Index, which is comprised of Euro member states, including France 32.2%, Germany 29.3%, Netherlands 11.0%, Spain 10.7% and Italy 7.2%, among others. Unlike other broad Europe ETFs, EZU does not include exposure to Switzerland or the United Kingdom.
For more information on European markets, visit our Europe category.