European stocks are putting in a solid run in 2019, bucking the recent growth downgrade from the European Central Bank.
The continent had a tough 2018 as the European macroeconomic backdrop slowed and Eurozone GDP grew around 1 percent. And the year-end weakness that affected U.S. equity markets also weighed on Europe. But since the beginning of 2019, Europe has perked up and the MSCI Europe Index has gained 13 percent year to date.
Many European-focused exchange-traded funds are reflecting these gains—and some are even beating the benchmark.
What’s behind the optimism in Europe? Morgan Stanley strategists wrote in a research note that the outlook for Europe’s economy and European equities is improving. Euro-area PMI data have improved since the beginning of the year and a rebound in the Chinese economy should help Europe’s export-driven economy. Job creation in Europe continues, albeit slower. European consumer confidence indicators also show resilience.
Graham Secker, equity strategist at Morgan Stanley, wrote in a separate late-April research note that global economic slowdown fears are abating as trade tensions fall and central banks become more dovish.
Jeremy Schwartz, global head of research at WisdomTree, says from a macro level the difference in the Federal Reserve’s monetary policy versus the ECB is also a factor. The Federal Reserve raised interest rates eight times in two years until its recent pause, while the European Central Bank maintains its ultra-loose policy.
“Europe is almost five years behind the U.S. when you think about where their economy is . . . but also on a market perspective. People are worried that we’re in a later cycle for the U.S. market, but perhaps Europe still has more to go. You can view the ECB versus the Fed as symbolic of that,” Schwartz says.
China’s rebounding economy is definitely helping Europe, Schwartz adds, as many European equity firms are multinationals doing business there.
Among the 70-plus European focused ETFs—both continent and single-country focused—the currency-hedged ETFs are leading the pack.
WisdomTree’s Europe Hedged Equity Fund (HEDJ) is one of this year’s best-performing currency-hedged ETFs, up 19 percent year-to-date. It has $3.9 billion in assets under management and an expense ratio of 0.58 percent.
HEDJ tracks an index comprising export-oriented, dividend-paying Eurozone companies, and the fund is hedged against the euro. It has gained 5 percent this year and is up 12 percent on a three-year annualized basis. Over five years HEDJ has returned 8 percent. The top three countries held include France (31 percent), Germany (20 percent) and Spain (16 percent). Consumer defensive, industrials and consumer cyclical make up the top three sectors at 23 percent, 16 percent and 14 percent, respectively.
By comparison, MSCI Europe on a one-year basis it is down 5 percent, and up 4 percent on a three-year basis. On a five-year basis it is down 1.6 percent.
Schwartz says the currency hedge gives HEDJ an advantage since it neutralizes the currency influence. “By taking currency off the table, you don’t get help if the currency goes up, but you don’t get hurt if the currency goes down,” he says.
What’s giving the currency-hedged HEDJ an extra oomph is the interest rate differential between the Fed and ECB. With German bunds at zero and the 10-year U.S. Treasury note at 2.5 percent, by hedging the euro exposure it’s adding a 2.5 percent gain on top of the equity exposure.
The biggest European ETF by assets is the Vanguard FTSE Europe ETF (VGK). It has $13.9 billion in AUM and an expense ratio of 0.09 percent. It’s up 15 percent year to date, but down 3 percent on a one-year basis. It has returned an average of 7.6 percent on a three-year basis and 1.6 percent during the past five years.
The fund tracks the FTSE Developed Europe All Cap Index, where the top three countries represented are the U.K. at 28 percent, France at 16 percent and Switzerland at 14 percent. The top sectors are financial services at 18 percent, consumer defensive at 14 percent and industrials at 13 percent.