PEP: Proper European Positioning For 2018

With the rebound in European equities expected to continue in 2018, now is the ideal time for investors to consider strategies beyond standard, cap-weighted funds that may lack leverage to recovering cyclical elements of Europe's various economies.

Many traditional Europe exchange traded funds have delivered solid returns this year — and are often heavily allocated to large- and mega-cap multinational companies that derive significant portions of their revenue from outside of Europe. That strategy can work in the early stages of a recovery, but a more domestically oriented approach can pay off as markets begin favoring cyclical fare.

The WisdomTree Europe Domestic Economy ETF (NYSE: EDOM) is already signaling the cyclical advantage. EDOM is up nearly 32 percent year-to-date compared to a 26-percent gain for the MSCI EMU Index.

Better Positioning

“The WisdomTree Europe Domestic Economy Index is designed to represent a pure play on the more local dynamics of the eurozone economy,”  WisdomTree said in a recent note. “Many investors often are forced into small-cap companies to avoid large-cap mega-nationals that often are driven by global sentiment, China and the emerging markets. The WisdomTree Europe Domestic Economy Index was designed to be all cap, but it targets sector exposures that benefit from more cyclical changes in growth.” 

The WisdomTree Europe Domestic Economy Index is EDOM's underlying index. EDOM lives up to its billing as a cyclical play. The ETF features no exposure to consumer staples, telecommunications or utilities stocks — sectors that are usually viewed as defensive.

“The European recovery at present has benefited from the tailwinds of global growth, but should the mature recovery in the U.S. lose steam or the emerging market growth engine pause, a domestically focused index should be less impacted by such external factors.,” said WisdomTree.

Where To Be

EDOM allocates 30 percent of its weight to previously controversial European financial services stocks, but as that sector has recovered, the ETF is benefiting. The good news for investors is that European banks still have plenty of room to run to regain pre-crisis highs.

“Over the past decade, in terms of price appreciation, the MSCI EMU Financials sector has outperformed only Utilities and has far from recovered to pre-crisis level as it has returned 42 percent,” said WisdomTree. “Simply a reversion to prior levels would spell great returns ahead.”

European financials are inexpensive relative to long-term averages and sport, on aggregate, higher dividend yields than their U.S. counterparts and broader European equity benchmarks.

Related Links:

A Leveraged Idea For The Next Fed Meeting

CURE The Boring December Trade