The iShares MSCI EMU ETF (CBOE: EZU) is up 11.54% year-to-date and while that fund and rival Eurozone exchange traded funds are trading higher, the region faces significant political risks that could potentially weigh on financial markets there.
Europe’s equities also look more attractive, with valuations of European and U.S. equities exhibiting their widest divergence since the end of 2016 on certain measures. According to FactSet data, the Stoxx Europe 600 was trading at 14 times forecast earnings, compared to the S&P 500’s 17 times, which represent a wider gap than its long-term average over the past decade.
“We expect euro-zone growth to pick up in the second half of this year. But the risks around our favorable base case are considerable – and they are mainly tied to potential political troubles,” said BlackRock in a recent note.
The Organization for Economic Cooperation and Development previously cut its forecast for Eurozone growth this year to 1%, from a 1.8% estimate back in November.
Risks To Consider in Europe
European markets have been mired by political risks surrounding Brexit, government finances in Italy and weak German growth. Additionally, talks of a new tariff spate with the U.S. also dampened investors’ moods. Sentiment also worsened after the European Central Bank cut forecasts for growth in early March.
“The UK has bought more time to hammer out a Brexit agreement, but uncertainty remains,” said BlackRock. “There may be renewed escalation of the trade tensions between the U.S. and EU, centered around car tariffs. U.S. President Donald Trump has until May 18 to decide whether to take action against European car producers on national security grounds. And European Parliament elections in late May could result in a populist sweep of protest parties from both ends of the political spectrum. This would further erode the influence of pro-European centrist political forces.”
Foreign investors also lost interest as the euro currency depreciated to a 22-month low against the U.S. dollar, which diminishes U.S. dollar returns. However, the weaker currency does make Europe’s export industries more competitive on the world stage.
“We believe the ECB should pause further steps towards policy normalization for the remainder of this year – and likely beyond – to ensure a return of inflation to its below-but-close-to 2% price stability objective,” said BlackRock. “At the upcoming meetings, the Governing Council will set the conditions for further long-term loans to banks (TLTRO3), discuss tiering of reserves and review its monetary stance.”
For more information on the European markets, visit our Europe category.