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 Eurozone.(1) This will no doubt have..
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dented investors’ confidence, especially in the wake of the accommodative monetary policies being implemented by the ECB. However, despite the downward revisions in GDP for the Eurozone, growth prospects remain strong, driven predominantly by exports and resurgent domestic demand.
Eurozone GDP Growth: Private Consumption Playing a Significant Role Recently
Eurozone GDP Cumulative Contribution (in percentage points) by Major Components since 2010 Q1
Domestic Growth Is Expected to Strengthen Further
Whilst net exports have been a key driver for growth in the Eurozone over the past few years, domestic demand, namely household consumption, has played an increasingly important part in the Eurozone recovery.
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 consumption growth, and the latest readings suggest that the trend might continue.
This growth is further supported by the ECB’s monetary easing and some of the monetary indicators that we follow, such as M1, imply continued support for this trend.
Economic Sentiment Indicator Leads Private Consumption Growth
Europe Nominal Private Consumption Growth2 vs. Economic Sentiment Indicator
Unique European Toolkit
Currency-Hedging: Many investors have become familiar with the WisdomTree Europe Equity UCITS ETF USD Hedged (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. More recently, WisdomTree has launched a new variety of share classes for HEDJ, offering the same access to European exporters but both hedged into different currencies including GBP and CHF, and also unhedged in euros as well.
Whilst HEDJ is well positioned to access global growth and a more competitive dynamic from the weak euro, we also expect favourable domestic demand dynamics to continue and investors can play the local recovery through European small caps.
Small Caps: WisdomTree Europe SmallCap Dividend UCITS ETF (DFE) was one of our first offerings to investors looking for European exposure and has continuously outperformed the broader and large-cap European markets since inception. This trend has continued into 2015 and one of the reasons for this is the idea that small caps are typically driven by domestic demand, unlike large caps which can have significant overseas exposure. A domestic-demand led recovery in the euro area should play into the hands of DFE which offers investors a cyclical bias as well as an emphasis on value-orientated quality stocks. If one believes in the local growth prospects of the region then small caps should continue to be in favour.
 Sources: 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.