SPDR ETFs: Three reasons why eurozone stocks have room to run

Aug 14th, 2017 | By | Category: Equities

By Matthew Bartolini, head of SPDR Americas research, State Street Global Advisors.

SPDR ETFs: Three reasons why eurozone stocks have room to run

Matthew Bartolini, head of SPDR Americas research at SSGA.

After a strong rally, eurozone stocks have lost momentum since May, hurt by a strengthening euro. In the past two months, the EURO Stoxx 50 Index has registered negative return in local currency and underperformed the S&P 500 Index by 5%, while flows into European equity ETFs have slowed to their lowest level since March.

However, we believe the headwinds from a stronger euro are transitory, and there are three tailwinds that could propel eurozone stocks higher in 2017: strong corporate earnings growth, improving economic growth and ongoing monetary easing.

Tailwind #1: Strong earnings growth prospects

A rising euro may create headwinds for eurozone companies, as goods produced in the region become more expensive for overseas buyers, thereby hurting earnings. Despite this, corporate earnings growth expectations for the eurozone remain upbeat. The most recent earnings growth estimates for 2017 are better than they were in the first quarter and at the beginning of the year. The region’s earnings growth continues to top its US counterparts, as shown in the chart below, and it is expected to do so for the rest of the year.

Eurozone equities – eurozone earnings growth forecast to outpace US earnings growth

Source: SPDR ETFs.

Tailwind #2: An improving economic outlook

In its latest World Economic Outlook, the International Monetary Fund (IMF) adjusted its projection of eurozone growth upward for 2017 and 2018, saying positive surprises since 2016 “point to solid momentum.”

In addition, inflation has firmed in the region, with both core and headline inflation close to their highest levels in three years, which is illustrated in the chart below. Meanwhile, the eurozone unemployment rate has steadily declined from its peak of more than 12% in 2013 to 9.3% in June 2017.

Consumer confidence is at its highest level post-financial crisis, while the Markit Eurozone Manufacturing Index is near a three-year high. Improving economic prospects and reduced political risk have also compressed bond spreads of France, Italy and Spain over Germany.

Eurozone inflation on the rise

Source: SPDR ETFs.

Tailwind #3: Accommodative monetary policy

Although some hawkish rhetoric emerged out of the ECB at the beginning of July, at its latest July policy meeting the bank kept interest rates unchanged and said it expected to keep rates at zero for “an extended period of time.” The ECB also left the door open for continuing its asset purchase program beyond December 2017 “if necessary.”

While the Federal Reserve could start unwinding its $4.5 trillion balance sheet as soon as September, the ECB’s normalization of balance sheets and interest rates is further down the road. Such accommodative monetary policy in the eurozone may provide a level of support for eurozone stock valuations.

A transitory headwind: A rising euro

The dollar has given back all its gains since the November US presidential election as investors dialed back expectations of an expansionary fiscal policy. But rising US interest rates may attract dollar buyers in the second half of this year, capping further euro strength. In December, the Fed is expected to hike rates for the fifth time since the financial crisis, while the ECB’s target interest rate for 2017 year-end is still zero. The expanding rate differential between the two currencies, shown in the chart below, might act to curb the euro’s rise.

Diverging accommodative policies: ECB vs the FED

Source: SPDR ETFs.

Two ETF solutions to capture eurozone growth

Eurozone equities are trading around a 15-year average—compared with 15-year highs for their US counterparts, based on price-to-book ratio, presenting investors a value opportunity. Eurozone stocks may have more room to run, given the improving economic growth and corporate earnings, combined with supportive monetary policy.

For investors who are concerned about headwinds from a rising euro but still want to capture positive economic trends in the region, eurozone small-cap stocks may warrant consideration. Because of their domestically focused business, they are less affected by foreign currency fluctuations and may capture more of the tailwinds from improving local economics. As illustrated in the chart below, the EURO Stoxx Small Cap Index has outperformed the broad market by more than 5% year-to-date.

Eurozone equity small cap v large cap YTD performance

Source: SPDR ETFs.

The EURO STOXX Small Cap Index is designed to provide exposure to small-cap companies in the eurozone, and investors can access this opportunity with the SPDR EURO STOXX Small Cap ETF (SMEZ). Investors seeking exposure to the eurozone’s leading blue-chip companies may want to consider the SPDR EURO STOXX 50 ETF (FEZ).

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

Tags: , , , , ,

Leave a Comment



More in Equities
Equities India ETFs
WisdomTree predicts multi-year bull market in Indian equities

By WisdomTree’s economic research team. We recently spoke with Ridham Desai, who heads Morgan Stanley’s India Equity Research. Desai recently made headlines when...

US Equity ETFs: US corporates can ride out eurozone crisis
Point Bridge to launch “make America great again” ETF

Texas-based Point Bridge Capital is to launch the Point Bridge GOP Stock Tracker ETF (MAGA), whose ticker code stands for “make America great...

Close