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A Surprising Source Of Value In European Equities

ETF Professor

Developed equity markets outside the U.S. have recently been showing some signs that investors are starting to embrace the value proposition offered in some of those regions. Small-cap stocks, which are often pricey in the U.S., can be part of that equation.

What Happened

Some ex-U.S. equity strategies have really been perking up as of late, a group including the WisdomTree Europe SmallCap Dividend Fund (NYSE: DFE).

DFE, one the steadier options when it comes to accessing European small-cap stocks, is higher by almost 9% over the past month.

DFE allocates nearly a quarter of its weight to the industrial sector, its largest sector allocation. That's a relevant trait at a time when European industrial data are showing rebound potential.

“European small-cap stocks have historically tracked the annual change in eurozone industrial production since 2000,” WisdomTree said in a recent note.

“The industrial sector constitutes the highest sector weight across European small caps (22%) in comparison to large caps (11%). The improvement in price performance of small- versus large-cap European stocks has historically signaled a rebound in eurozone industrial production.”

Why It's Important

In Europe, the U.K. dominates the small-cap scene. In the eurozone, that status is commanded by Germany, explaining why the two countries combine for over 35% of DFE's weight.

The fund's 2019 performance has come against the backdrop of Brexit and concerns about a slowdown in the German economy.

“Brexit has been a considerable drag on small-cap performance,” said WisdomTree. “The U.K. is the largest and oldest small-cap market in Europe, representing 33% of the small-cap universe in Europe. As we receive more clarity on the path U.K. might follow in its departure from the EU, this removes one major challenge to investor sentiment.”

For its part, Germany has been making some efforts to prop up the eurozone's largest economy, but WisdomTree said those are enough and that more aggressive stimulus is needed.

“We expect the recent run of weak German economic data releases to eventually persuade the country to unleash a more meaningful round of fiscal stimulus,” according to WisdomTree.

What's Next

With DFE, investors get a dividend yield of 3.73%, 232 basis points above the S&P SmallCap 600 Index, with valuations that are attractive relative to U.S. small caps.

“Further, European small-cap stocks are attractively valued compared to large caps. The price-to-earnings ratio (P/E) of small- versus large-cap European stocks is trading at a 7% discount compared to its average since 2007,” according to WisdomTree.

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