Is Europe Making a Comeback?

by on November 14, 2013

A move by the European Central Bank to cut interest rates to a record low of 0.25% has specific implications for improving investor confidence. Dodd Kittsley explains.

A battered Eurozone seems to be on a slow road to recovery. Spain finally emerged from its two-year recession in the third quarter, and this summer marked the first time in three years that the Eurozone didn’t suffer from a financial crisis. Last week, the European Central Bank lowered interest rates to 0.25%. These signs of life highlight improving economic signals and investor confidence in the region – a sentiment echoed by our own Russ K – and are sparking a surge in select European ETF flows.

Pan-European Equities

Investors flocked to German equities during the height of the Eurozone crisis in 2011, seeking stability in core countries and dumping pan-European exposure. Today, we’re witnessing the exact opposite. ETF flows data shows a 52% increase in inflows for pan-European equities since July. In October alone, the sector witnessed a record $7.9 billion in inflows, breaking records for the third consecutive month in a row. UK equities followed, growing 18% over the past month. Emerging markets and Japan equities saw 15% and 14% growth, respectively, while the U.S. lagged them all with an 11% growth rate. 

By taking a “reverse defense” strategy, it seems investors are now pursuing a more diversified approach. The following chart illustrates this trend during the month of October:

Europe 2

In his latest Investment Directions report, Russ Koesterich says “we continue to advocate a benchmark weight to the Eurozone. Economic data continues to look promising, adding to signs that the single-currency bloc’s recovery is gaining momentum. Eurozone company valuations also still looked depressed relative to U.S. company valuations and the region’s corporate earnings are likely to have troughed. But while cyclical risk is taking a backseat, policy and political uncertainties are rising. These include lengthy coalition formation in Germany that is stalling the region’s much-needed banking union reform, Greece and Portugal bailout reviews, and upcoming asset quality reviews by the ECB.” In terms of broad pan-European exposure, a potential solution is the iShares Europe ETF, or IEV. For exposure to countries in the European monetary union, or for UK exposure, potential solutions include the iShares MSCI EMU ETF, or EZU, and the iShares MSCI United Kingdom ETF, or EWU, respectively.Europe 1

What’s Next for Europe

The ECB’s recent announcement that it will lower interest rates to 0.25% provides even more of a catalyst for Eurozone pan-European equities and fixed income. However, there are reasons to be cautious with pan-European equities. Russ K noted earlier this fall that while the situation in the region is beginning to show signs of improvement, risks still remain. As for interest rate adjustments and the resulting positive impact on fixed income, we believe that the ECB will hold off on increasing rates until long after the Fed starts to pull back on its easy money policy.

Dodd Kittsley, CFA, is the Global Head of ETP Research for BlackRock and a regular contributor to the The Blog

Sources: BlackRock, Bloomberg, Eurostat, Bank of Spain, UK Office for National Statistics, Reuters

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Securities focusing on a single country may exhibit higher volatility.