Europe, not just a vacation opportunity

Heidi discusses the case for eurozone equities, despite the abundance of political uncertainties.

With U.S. markets rallying and considerable political uncertainty across Europe, the only thought many U.S. investors may have regarding Europe is whether the strong dollar means a summer vacation there should be in the works. While I always enjoy planning my next adventure, investors may want to consider Europe as an investment opportunity, not just a vacation spot.

Indeed, after a year of considerable outflows, European equity exchange traded products (ETPs) started seeing inflows in late 2016, gathering over $6.8 billion globally since November (source: BlackRock, as of 1/31/2017). Despite significant political risk ahead, eurozone equities may be worth considering for three key reasons:

Stronger economic growth

Leading indicators of eurozone growth have picked up to multiyear highs as global growth momentum has spread from the U.S. to other regions, including the eurozone, according to BlackRock data. Additional data such as a pickup in loan demand, as signaled in European Central Bank’s Q4 lending survey, suggests this trend could be sustained further.

Earnings momentum

An earnings recession will likely end this quarter and eurozone equities may see a rebound in profitability as a weaker euro and a reflationary environment bring earnings estimates higher, led by banks and commodity-related sectors. In addition, headwinds from recent years including extremely low inflation and weak emerging market growth, seem to be abating. Earnings revisions are accelerating at one of the fastest rates in developed markets and could help drive eurozone equities’ performance (source: Thomson Reuters).

Attractive valuations and light investor positioning

On a price-to-book (P/B) basis, eurozone equities have been trading close to historical lows versus broad developed markets. Nevertheless, although the improving backdrop has led to some inflows in recent weeks, investor participation in the region remains low, especially after post-Brexit outflows, which outpaced those during the European debt crisis (source: BlackRock).

To be sure, Europe’s political uncertainty is rising this year. Brexit negotiations are underway, and a potential victory by Marine Le Pen in the French election could spark further doubt about the future of the European Union. Add to that elections in the Netherlands, Germany and possibly Italy, and this could be a tumultuous year for Europe. What’s more, a potential slowdown in global reflation, flatter yield curves and sharp moves in the euro are additional factors we’ll keep an eye on as we progress through 2017.

That said, the region may fare well in a better global growth environment and find current valuations to be a potentially attractive entry point into eurozone equities. Investors looking to access eurozone equities may want to consider iShares MSCI Eurozone ETF (EZU), iShares Currency Hedged MSCI Eurozone ETF (HEZU), or iShares Core MSCI Europe ETF (IEUR).

Heidi Richardson is Head of Investment Strategy for U.S. iShares and a regular contributor to The Blog.

Maria Eugenia Heyaca, an ETF Investment Strategist, contributed to this blog.

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