Amid the recent global financial market turmoil, both the European Central Bank (ECB) and the International Monetary Fund (IMF) have downplayed the near-term economic recovery in the euro area.1 This downward revision was no doubt a serious hit to investors’ confidence in the region’s growth prospects, especially in the wake of the accommodative monetary policies being implemented by the ECB, which was expected to pull the struggling area out of the mud and get its growth back on track. What went wrong?
Both agencies cited deteriorating external factors that were dragging down their projections.2 Global trade has lost significant momentum in recent years, and the gloomy growth outlook of major emerging market economies has dampened foreign demand further. Export growth in the euro area—despite a weakening euro—has yet to contribute meaningfully to gross domestic product (GDP) growth. The trade component of GDP growth has become almost a non-factor, as compared to the major impact it had in the second quarter of 2011.
On the other hand, private consumption expenditures have been making up for the slack in the trade component and are largely responsible for keeping the euro area’s economic recovery alive. Yet it may not be wise to dismiss the strength of domestic consumption growth altogether and thus ignore the embedded investment opportunities, as we expect favorable domestic dynamics to continue.
Domestic Growth Is Expected to Strengthen Further
Confidence is a key to economic growth. At WisdomTree, we closely watch the European Commission Economic Sentiment Indicator, which is a timely composite measure of business and consumer confidence in the region. Historically, it has been a reliable leading indicator for the region’s economic activities. As illustrated in the figure below, it leads the eurozone nominal private consumption expenditure growth quite well. The increased confidence has been a tailwind to the consumption growth, and the latest readings suggest the trend might continue.
Unique European Toolkit
WisdomTree has been creating tools to position for various scenarios in the eurozone economy. Many investors have become familiar with the WisdomTree Europe Hedged Equity Fund (HEDJ), which tracks the performance before fees of European exporters while at the same time neutralizing the impact of the euro’s performance against the dollar. HEDJ is well positioned to access global growth and a more competitive dynamic from the weak euro. But there is also this local recovery side of the European equation, and there is now more than one option for getting this exposure.
Small Caps: Among our first exposures to the European markets have been European small-cap companies. In particular, the WisdomTree Europe SmallCap Dividend Fund (DFE) has been leading the broader and large-cap European markets higher in 2015,3 and one of the reasons for this is the earlier economic discussion: small caps typically are much more local to the European economy than large caps. If one believes in the local growth, small caps should continue to be in favor.
But not everyone wants to have full exposure to European small caps as they would to large caps. This led WisdomTree to create a new strategy geared to the local demand dynamics in the eurozone but that narrows from the total market universe.
Unhedged Local Recovery: EZR, the WisdomTree Europe Local Recovery Fund, expands WisdomTree’s European toolkit to include a broader-based, all-cap-inclusive strategy positioned for a local economic recovery in the eurozone.
In a series of upcoming blog posts, we will discuss the Index methodology that drives EZR and how it can complement existing European strategies quite well for a more finely tuned exposure to this local growth story.
1Sources: “ECB Staff Macroeconomic Projections for the Euro Area,” ECB, 9/15; and “World Economic Outlook: Adjusting to Lower Commodity Prices,” International Monetary Fund, 10/15.
2Sources: “ECB Staff Macroeconomic Projections for the Euro Area,” ECB, 9/15; and “World Economic Outlook: Adjusting to Lower Commodity Prices,” International Monetary Fund, 10/15.
3Sources: WisdomTree, Bloomberg; refers to the period from 12/31/14 to 9/30/15, where the WisdomTree Europe SmallCap Dividend Fund outperformed the MSCI Europe Index, a broad market cap measure of European securities.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. The Fund focuses its investments in Europe, thereby increasing the impact of events and developments associated with the region, which can adversely affect performance. Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. A Fund that has exposure to one or more sectors may be more vulnerable to any single economic or regulatory development. The Fund invests in the securities included in, or representative of, its Index regardless of their investment merit, and the Fund does not attempt to outperform its Index or take defensive positions in declining markets. As the Fund can have a high concentration in some issuers, the Fund can be adversely impacted by changes affecting those issuers. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
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