Do Europe ETFs Have More Upside?

The Euro zone saw a strong start to the year thanks to economic improvement, rising inflation and the end of earnings recession. The Eurozone economy grew 0.4% sequentially in Q4 of 2016, in line with market expectations. As per Financial Times, Europe’s mutual funds saw a net €210 billion in investment in the first three months of the year, marking the highest quarterly inflows in five years.

Broader Europe ETF Vanguard FTSE Europe ETF VGK is up over 13% so far this year while Euro zone ETF iShares MSCI Eurozone EZU has gained about 15% in the year-to-date frame (as of May 2, 2017). FI Enhanced Europe 50 ETN FIEU has added over 25% this year. These were in contrast to 6.8% year-to-date gains seen in the S&P 500-based ETF SPDR S&P 500 ETF (NYSE:SPY) (AX:SPY) .

After these stellar gains, it is quite natural for investors to think how long this monster rally in Europe ETFs will continue or if these funds will soon run out of gas. Let’s find out which factors can act as tailwinds and the ones that are headwinds:

Upbeat Earnings

As per Reuters, about a third of the MSCI Europe companies came up with its first-quarter results, wherein corporate profit growth in the region was almost as healthy as that of the U.S. Overall, for the first quarter, earnings in Europe are expected to increase 13.9%, according to Thomson Reuters I/B/E/S, while the S&P 500 earnings are expected to grow 11.2%.

Factory Activity at Six-Year High

Euro zone’s manufacturing activity rose at the quickest clip in six years in April demand remained solid despite rising prices, as per IHS Markit's Manufacturing Purchasing Managers' Index. Per the gauge, factory activity in Euro zone rose to 56.7 in April from March's 56.2, the best since April 2011. However, the reading was slightly lower than the preliminary reading of 56.8.

Better Prospect than the U.S.?

On a relative basis, the fading Trump rally in the U.S. may lead to further buying opportunity in the Europe stocks and ETFs. The Euro zone expanded faster than the U.S. in 2016 for the first time since 2008.

As per the respondents to the ECB Survey of Professional Forecasters (SPF), expectations for Euro area GDP growth for 2017 ticked up to 1.7%, up 0.2 percentage points. The economists forecast that growth in the bloc rose from 0.4% to 0.5% at the start of 2017. This is slightly slower than the U.S. economy’s Q1 advancement of 0.7%. Plus, the U.S. manufacturing sector slowed in April from last month (read: GDP, Manufacturing Data Soften: ETFs to Play the Dip).

Investors should note that Euro zone still has the ECB’s easy-money backing and more room for improvement while the U.S. economy has seen the end of QE and has now moved onto policy tightening. Plus, if Trump’s proposed policies fail, U.S. stocks may see a slide, steering investors toward Europe (read: 5 ETFs to Buy if Trump Tax Reform is Enacted by Year End).

Threats Exist Too

However, there are factors that may derail the momentum. Below we highlight some:

If ECB Tightens Soon

Though the ECB continued to promise more accommodation if required, there is hearsay that this assuring tone may change in the bank’s June meeting (as per an article published on fxstreet.com), given continued progress in the bloc. If his happens, the rally may halt.

If Le Pen Wins France Election

Though far-right candidate Marine Le Pen – who is viewed as a supporter of ‘Frexit’ – has lesser chances of winning the election on May 7 (as per polls), polls may be misleading. If the opposite happens, we might see some sell-off in Europe ETFs (read: 5 European ETFs Soaring on French Election Results).

That being said, we would like to note that sentiments are still strong in Europe investing. We highlight below a few ETFs that hit a 52-week high on May 2.

Hot Europe ETFs

Direxion Daily FTSE Europe Bull 3X ETF EURL – Up 44% YTD

It gives triple exposure tothe FTSE Developed Europe All Cap Index, which is a market capitalization weighted index designed to track the equity market performance of large, mid and small-cap companies in developed markets in Europe.

WisdomTree Europe SmallCap Dividend ETF DFE – Up 17.5% YTD

The fund gives exposure to the small-capitalization segment of the European dividend-paying market.

iShares MSCI Europe Small-Cap IEUS – Up 17.5% YTD

The underlying index focuses on small cap representation across the 15 developed countries in Europe.

Wisdomtree Europe Hedged Small Cap Equity ETF EUSC – Up 15.6% YTD

The fund provides exposure to European small-cap companies while hedging exposure to fluctuations between the U.S. dollar and the euro.

Europe Alphadex Fund FT FEP – Up 17.3% YTD

The fund follows an index which is a modified market capitalization weighted index that employs the AlphaDEX stock selection methodology to select stocks from the NASDAQ Europe Index.

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