Europe has been the center of most discussions this year. After suffering from the longest recession in decades, European equities started picking up towards the end of last year. However, the going hasn’t been easy for them in 2014, barring Germany, as growth in most of the nations within the Euro zone remained muted.
Economic and business activity within the zone slowed for the second straight month in June, signaling that there are still some areas of worry. France, the second largest member country, is posing a real threat to recovery, with its economy still hovering near stagnation. Moreover, the much stronger German economy appears to be losing momentum.
In fact, the threat to growth was so alarming that the European Central Bank (:ECB) last month announced a slew of measures to stimulate the economy and fight against deflationary pressures. The ECB became the first major central bank to bring down interest rates to negative territory in order to force banks to boost lending and spur business activity.
Also, growing tension in Russia and escalating violence in Iraq dampened the economic recovery and led to waning business confidence in the region. The recent Malaysian Airlines jet crash near the Russian/Ukrainian border has deepened the conflict between the two nations. This came on the back of fresh sanctions imposed by the U.S. against Russia (read: Russian Sanctions and Malaysian Plane Crash Put These ETFs in Focus).
The Good News
Though things might not be in good shape within the economy, they are however gradually improving. The corporate earnings picture in Europe is expected to be better than previously estimated.
Earnings for the S&P Europe 350 are projected to expand by 7.1% during the second quarter, which is a more than five percentage point improvement from the forecasts back in April, according to Wall Street Journal.
Companies in the S&P Europe 350 stock index are expected to report 10.2% growth in earnings this year as compared to 7.8% expected for U.S. companies.
Also, while profits for U.S. companies are at record levels, European earnings are still quite low as compared to before the financial crisis. This indicates that European earnings still have more room for upside, holding out hope for their equities.
Moreover, ECB’s easy monetary policies are likely to provide further boost to European equities. While the Fed is winding down its asset buying program, the ECB is implementing easy monetary policies and rumors are rife that it might even have to resort to quantitative easing to bring its economy back to health (read: Negative Interest Rates Put These European ETFs in Focus).
Further, after a five-year bull run, most of the U.S. stocks look pretty expensive with stretched valuations. On the other hand, the European recovery is just one-year old and the European stocks are still trading significantly lower than their pre-crisis levels.
European stocks traded at a 23% discount to U.S. stocks at the end of the second quarter, as reported in an article by Paul J. Lim. This is quite higher than the historical average discount of 12%, suggesting that European stocks have much room for upside and might outperform U.S. stocks since they are relatively cheaply valued.
What Should Investors Do?
Admittedly Europe is showing a sluggish economic recovery amid heightening concerns of a geopolitical crisis not seen since the end of the Cold War. Despite this, the continent still provides investment opportunities and is relatively trading at cheaper valuations as compared to the U.S.
Many investors might be left wondering which ETFs to invest in given the difficult times. This is especially true as almost all the European ETFs have yielded negative returns in the past one month.
One way to narrow down the list is to utilize the Zacks ETF Rank. This system looks to find the best ETFs in a given market segment based on a number of factors including market outlook, expenses and tradability.
Below we have highlighted two top ranked ETFs that provide exposure to a broad basket of European equities, for investors keen to use the current sluggishness in the space as a buying opportunity (see all European Equity ETFs here).
The ETFs have a Zacks ETF Rank of 2 or ‘Buy’ rating and are thus expected to outperform in the months to come.
Vanguard FTSE Europe ETF (VGK)
VGK is the largest and most popular ETF in the space with an AUM of $16.9 billion and an average trading volume of more than 3 million shares a day. Apart from being the largest, the fund is the cheapest bet in the space charging 12 basis points as fees.
VGK provides a diversified exposure to a large basket of 515 European companies. Sector-wise, Financials occupies the top spot, followed by Consumer Defensive and Health Care. UK, France, Germany and Switzerland form the top exposure in terms of countries.
The product has been one of the top asset gainers during the first half of the year led by a super-easy monetary policy in the region. The fund has returned 22% in the past one year and 4% this year (read: ETF Asset Report for the First Half of 2014).
SPDR STOXX Europe 50 ETF (FEU)
The fund tracks the STOXX Europe 50 Index, measuring the performance of some of the largest companies in the Euro zone. FEU holds 57 stocks, with Nestle, Novartis and Roche Holding Ltd occupying the top three spots, having roughly 5% exposure each.
Financials, Health Care, Consumer Staples and Energy dominate the fund with double-digit exposure. Country-wise, U.K. occupies the top spot with more than one-third exposure, followed by Switzerland and Germany.
The fund is rich with AUM of $273 million while the expense ratio is also quite cheap at 29 basis points annually. Volumes are moderate with average trading volume of 75,000 shares. FEU has returned 20.5% in the past one year and 4% in the year-to-date frame.
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