In what might feel like an eternity to some, European stocks and the related ETFs are performing admirably this year. In some cases, delivering returns that aren’t far off the pace set by domestic benchmarks.
For example, the MSCI EMU Index was higher by 9.3% year-to-date, not far off the 9.9% gain offered by the S&P 500. Some Europe ETFs are doing better than that. For example, the WisdomTree Europe Hedged Equity Fund (HEDJ ) is quietly beating the S&P 500 by more than 200 basis points per year. That gap could widen in favor of HEDJ if some market observers’ recently bullish views on European stocks are validated.
HEDJ Outlook: More Than Just Rates
There are expectations that rates will remain higher for longer in the U.S. Additionally, the European Central Bank (ECB) may be far closer to rate cuts than the Federal Reserve. However, the currency-hedged HEDJ could be a candidate for out-performance among Europe ETFs if the euro trends lower against the dollar. But other catalysts could boost the case for HEDJ.
As measured by the equity risk premium (ERP), European stocks, including HEDJ components, are attractively valued relative to U.S. equivalents.
“The ERP in Europe is 2.1pp [percentage points] above the US, close to a record high. The sector-adjusted P/E at 18% below the U.S. has only been at similar or lower levels when there is a recession/Eurozone crisis. We have neither,” observed UBS strategists in a recent report entitled “A U-Turn: Favouring Europe over US equities.”
European EPS Growth Attractive
UBS data indicates Europe currently sports an ERP that’s well over that of the U.S. But the case for HEDJ isn’t solely supported by European equities being inexpensive. Those depressed multiples are notable. Why? European earnings per share (EPS) growth is attractive in its own right.
“European profit margins (critically, ex financials) are far less extended than the U.S. And in the U.S. 67% of the margin improvement came from unsustainable factors (lower rates and lower tax) compared to just 3% in Europe,” adds UBS.
The $1.98 billion HEDJ allocates 85.11% of its portfolio to nonfinancial services stocks. Speaking of sector exposures, the ETF’s allocation to consumer cyclical stocks is 24.55%. That’s its largest sector exposure. It could prove compelling as eurozone GDP growth closes the gap with U.S. and as European consumers potentially spend excess savings.
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