The European economy may be turning the corner, with demand for credit up and retail sales jumping at the fastest three-month rate in the last 15 years at 8.65%.
Investors noticed the improvement, and just in the last 2.5 months, poured $9.2 billion into WisdomTree’s Europe Hedged ETF, which shorts the Euro to take out the currency risk. This nearly triples the amount of assets in the fund from $5.6 billion on 12/31/14 to $14.8 billion as of yesterday.
Germany’s DAX index is up 20% with France not far behind up 17% in 2015, however, the Euro actually fell 12% against the U.S. dollar, partially driven by the flows to currency-hedged ETFs. Others recognize the extremely low interest rates in Europe and Germany, whose 10-year debt saw its yield plunge below 0.20% this week. This compares to the U.S. Treasury 10-year at 2.10%, where investors are picking up almost 2% in yield.
Over the long-term, this negative relationship between the Euro currency and stock performance is quite prevalent (it is -0.5 over the last 1985). The yellow area chart shows the ratio of the S&P 500 to Europe is above the levels of 1985 and 2002, driven by the quickly falling blue line, which depicts the Euro and a model of how its predecessor would have traded prior to its existence in 1999.
The European Index trades at 8.5X its Price to Cash Earnings ratio (P/CE), or in the 93rd percentile of history since 1980. In other words, this ratio has only been more expensive 7% of the time. In addition, according to Morgan Stanley, the median stock’s P/CE ratio is 12.9, higher than in 2000 or in 2007.
Expectations for the economy are turning and investors are embracing European stocks. Just a few years ago, when prices were much lower, investors shunned most equities in the region fearing the worst with the debt problems of Greece and peripheral nations. These fears seem to have subsided for now. Forward return expectations should be tempered given where prices stand today.
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