The Europe Crisis Could Mean Opportunity with This ETF

As Verad Weekly Research’s Dan Rasmussen and team point out in a recent note, as of last week, 13 European equity markets were sporting drawdowns of 20% or more from prior highs. That dubious group includes Germany, the Netherlands, and Austria — all of which were down 30% from previous peaks. Proving geography matters, the closer a country is to Ukraine, the worse its markets are performing as highlighted by peak-to-trough declines of 40% for Hungary and Poland.

Those are ominous data points to be sure and not likely to generate enthusiasm for European small-cap stocks. However, the Verdad team notes that European small-cap value names have historical track records of rebounding following periods of crisis. That could be a sign that investors may want to put the WisdomTree Europe SmallCap Dividend Fund (DFE A) on their watchlists.

“Just like in the U.S., European small value stocks outperformed the market consistently and significantly after crises. The reason for small value stock outperformance in the wake of a crisis is simple, as crises unfold, small value stocks experience more severe sell-offs than the broader market. Their operations tend to suffer more in the context of plunging revenues and cash flows, coupled with weaker balance sheets and skyrocketing borrowing costs,” according to the Verdad team.

The team examined periods of severe market stress — the Russian/Asian debt crisis of 1998, the 2000 tech bubble, labor market distress in 2003, the global financial crisis, Europe’s 2011 sovereign debt crisis, and the 2020 coronavirus bear market.

Potentially underscoring the case for DFE, the average return for European small-cap value stocks 12 months after the crisis was 13% and the only one of those six periods in which European small value fare wasn’t higher a year later was the 2011 sovereign debt scenario.

“However, the same two factors that worked against small value stocks as crises unfolded — plunging valuations and muted growth — are the ones that reward the ‘survivors’ when crises bottom out and markets are poised for recovery. As a result, buyers of small value stocks in times of crisis pay less (thanks to cheaper valuations) and get more (thanks to above-average earnings growth during the recovery),” added Verdad.

As a dividend fund, DFE is likely full of survivors. While no European market is perfect at the moment, DFE offers investors the benefits of favorable geography as the U.K., Sweden, and Italy combine for about half of the ETF’s geographic exposure.

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