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Revisiting Europe ETFs Thanks to Attractive Valuations

This article was originally published on ETFTrends.com.

After rallying last year, European stocks and the related exchange traded funds are disappointing investors in 2018. For example, the SPDR EURO STOXX 50 (FEZ) is lower by nearly 7% while the SPDR STOXX Europe 50 ETF (FEU) is off by a comparable amount.

The $3.44 billion FEZ tracks the EURO STOXX 50 Index, a benchmark that focuses on Eurozone equities. The $203.23 million FEU follows the STOXX Europe 50 Index, featuring significant exposure to U.K. and Swiss stocks along with Eurozone equities.

Some investors are growing increasingly wary of European banks as ETFs tracking financials saw net outflows in Europe and the U.S. Goldman sachs research found mutual funds were on average holding fewer bank shares than benchmark indices and even raised short positions on the sector year-over-year. However, some market observers believe opportunities remain with European stocks.

“We believe Europe will still grow this year, but in a moderately disappointing way compared to 2017. Our current forecasts for the region are 2.2% annual GDP growth for 2018 vs. 3.8% for the US. However, the risks are more likely to the downside given the headwinds facing the region,” said State Street Global Advisors (SSgA) in a note out Monday.

Attractive Europe Valuations

European stocks sport compelling value relative to major U.S. equity benchmark. European cyclical stocks are attractively against U.S. equivalents, which is a positive for FEZ. The ETF devotes over 47% of its combined weight to cyclical financial services, industrial and consumer discretionary names.

“The challenge is that attractive European relative valuations are often the case, and there has not been a consistent catalyst to see that valuation discount realized,” said SSgA.

Related: Banks Drag Europe ETFs Down on Turkey Uncertainty

FEZ holds 51 stocks and allocates over 70% of its combined weight to France and Germany, the Eurozone's two largest economies. Financial services and industrial stocks combine for over a third of the ETF's weight. One catalyst that could spark European stocks is a rebound in return on equity (ROE). European stocks have sharply lagged U.S. rivals on that metric for several years.

“Over the last five years, Europe has lagged the S&P 500® Index by 50%, and by 6% since the start of 2018. This is because the return on equity (ROE) for European companies is 700 basis points lower on average than for US companies. This gap needs to close for European valuations to catch up with those of the US,” according to SSgA.

For more information on the European markets, visit our Europe category.