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An ETF For The End Of The European Malaise

October 23, 2019 8:15 am
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An ETF For The End Of The European Malaise

That is assuming the underperformance of European stocks relative to their U.S. counterparts comes to an end. Pinpointing exactly when that's going to happen is another matter, but investors can prepare for that event with the WisdomTree Europe SmallCap Dividend Fund (NYSE:DFE).

What Happened

DFE, which tracks the WisdomTree Europe SmallCap Dividend Index, is showing some signs of life. The WisdomTree fund is higher by 3.1% over the past month while the S&P Europe 350 Index is up 1.8% over the same period.

Components in DFE's index are weighted on the basis of cash dividends paid, providing investors with a quality trait and some buffer against the volatility associated with small caps and, sometimes, European equities.

Why It's Important

European stocks are in the midst of a 10-year stretch of significant underperformance against their U.S. rivals, something many investors assume is attributable to weakness in the region's banks.

That's relevant to DFE because financial services is the fund's second-largest sector weight at 17.69%, but that assumption requires closer examination. As recent research by WisdomTree suggests, much of the European malaise can be blamed on slack earnings growth.

“The higher returns in the U.S. were fully supported by underlying fundamental earnings trends: European earnings contracted 23% cumulatively over the last decade while U.S. earnings grew over 40%,” said WisdomTree in a recent note. “The average annual growth rate differentials in these earnings metrics is close to 6%, which is essentially the same difference in relative outperformance between each equity market.”

For DFE's part, the fund is overweight consumer discretionary and industrial stocks, two sectors with decent earnings growth, relative to the MSCI USA and Europe benchmarks. Those sectors combine for almost 42% of DFE's weight.

What's Next

There, as usual, remains lingering uncertainties in Europe, including Brexit and Germany's economy teetering on the brink of recession. Those two countries combine for 36.4% of DFE's geographic exposure, but the fund could prove resilient going forward while extending its out-performance of large-cap Europe ETFs.

DFE “has high sensitivity to the local economy in Europe, and we’d expect any impulse from more positive growth dynamics to support small caps over large caps,” according to WisdomTree.

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