Europe’s P/E Ratios Can Keep Recovering

ETF Trends

So much for the notion that the U.S. is the cleanest shirt in a hamper full of dirty developed markets laundry.

While Eurozone unemployment hovers at record highs, investors are embracing European equities. The Vanguard FTSE Europe ETF (VGK) is one of the top 10 ETFs this year in terms of inflows and last month, Pan-European ETFs raked in $7.9 billion last month, the third straight month of record-breaking inflows, according to BlackRock data. [ETF Inflows Surging Despite Government Antics]

Relative to the forward P/E ratios seen earlier this century, some Eurozone markets today trade at discounts even after recent, impressive runs for some Europe ETFs. In the past three months, VGK is up 5.6%, but the SPDR EURO STOXX 50 ETF (FEZ) is higher by 7.6%. [Big Europe ETF, Rivals Shine]

“The question is whether there is more upside for the region’s valuation multiples,” writes Dr. Ed Yardeni, president and chief investment strategist of Yardeni Research. “I think there might be, but forward earnings, which has been flat-lining since 2011, as I noted yesterday, needs to show some signs of life.”

Yardeni notes that Italy and Spain, the Eurozone’s third- and fourth-largest economies, respectively, trade with forward P/E ratios of 12.1 and 13.9. In 2004, Italy was above 16 while Spain was slightly above 14, according to Yardeni Research data.

Yardeni points out that European data point more to recovery than a bottoming. Perhaps in an effort to bolster that recovery, the European Central Bank surprisingly cut interest rates to a record low of 0.25% on Thursday.

European exporters, including those in Germany, the Eurozone’s largest economy, have been hampered by a strong euro. Any ongoing weakness in the common currency should benefit ETFs such as the WisdomTree Europe Hedged Equity Fund (HEDJ) and the db X-Trackers MSCI Europe Hedged Equity Fund (DBEU) , which hedge euro exposure. [Surprise Rate Cut Doesn't Do Much for Europe ETFs]

The potential for sustained Eurozone economic recovery along with higher equity prices underscores the importance of proper evaluation of Europe ETFs.

VGK’s performance has been impressive and its 0.12% expense ratio is lower than 93% of comparable ETFs, according to Vanguard. However, VGK allocates a combined 47.2% of its weight to the U.K. and Switzerland, meaning the ETF is not as intimately correlated to a Eurozone recovery as some investors may think.

While Switzerland and U.K. ETFs have been stout performers this year, investors may want to consider ratcheting up their Eurozone exposure via ETFs such as FEZ and HEDJ, which feature higher leveraged to the Eurozone trade.

DBEU, which debuted last month, hedges currency exposure to the euro, British pound, Swiss franc and select Nordic currencies, has gained 4.1% since it came to market.

Europe Forward P/E Ratios

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Chart courtesy: Yardeni Research

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