European equity ETFs have experienced a strong net inflow this year. Although the market is driven in the short term by news, investors are ready to expand their positions. Both the inflow into financials and that into industrials is noteworthy.
This was stated by equity strategist Rebecca Chesworth of State Street SPDR ETFs in mid‐February during an interview with Investment Officer. After years of underperformance, the European equity market has gotten off to a far better start this year than Wall Street. The fact that the old continent is once again popular with investors is also reflected in the regional allocation of ETFs. In January, there was a net inflow of 2.6 billion dollars into European equity ETFs, according to figures from State Street on ETFs listed in Europe.
In the preceding two months, there had overall been an outflow. “We saw the inflow bounce back after Donald Trump’s inauguration,” Chesworth said. “Trump immediately announced import duties on products from Mexico and Canada, but Europe was spared the impact. This provided relief among investors. Very little is required to rekindle institutional investors’ interest in Europe. European equities are cheap and significantly underweighted in investment portfolios.”
Checklist
Although President Trump now threatens to swiftly introduce import duties on the European Union as well, the positive trend continues. From 1 January to 14 February the net inflow amounted to 6.7 billion dollars. Chesworth is reluctant to say whether there is indeed a trend reversal. “Institutional investors essentially have a checklist that Europe must meet before they systematically allocate more money to the region.”
There are concerns about the uncertain political situation in several European countries. According to her, these worries may subside following the positive election outcome in Germany. Another delicate issue is the weak economy. “If Germany increases its stimulus, growth in Europe could pick up—especially if the situation in China also improves. Furthermore, an end to the Ukraine war would naturally boost sentiment in the European equity market.”
Finally, there are structural problems in Europe that deter investors, such as complex regulations which undermine competitiveness. Unfortunately, these issues are unlikely to disappear quickly, Chesworth believes. “Taken as a whole, the outlook for Europe is not uniformly positive, so a sustained recovery in sentiment is not yet on the cards. But as mentioned, the region is so cheap and underweighted that the inflow could accelerate following favourable news, for example regarding a resolution to the conflict in Ukraine.”
Conversely, negative news regarding American import duties is likely to quickly lead to profit-taking in Europe, Chesworth fears. However, she remained optimistic about European equities in the longer term. “Over a period of six months, many investors will ultimately return to Europe and use market corrections to expand their positions.”
Banks in demand
In January, flows were directed towards broad equity indices such as the MSCI Europe and the Stoxx 50. There is a clear preference for continental Europe, as the United Kingdom has so far experienced an outflow this year. At the sector level, the strong inflow into financials is particularly notable, both in Europe and in the United States.
“One of the driving forces behind the rising prices of European bank shares is the anticipated consolidation in Europe. There are simply too many banks at the moment, and the market expects more takeovers and mergers,” Chesworth said. She is sceptical about cross-border bank mergers in the European Union due to integration risks. However, she believes there is ample room for domestic consolidation in various countries, which creates considerable excitement around bank shares.
Another factor benefiting banks and other cyclical sectors is the somewhat improved economic outlook in Europe. Chesworth commented, “Confidence among consumers and businesses is gradually picking up. Moreover, company figures for the fourth quarter have so far been much better than expected. Analysts are revising their earnings estimates upwards, and that is one of the driving forces behind the price increases in Europe.”
Yet another positive surprise
Not only are financials showing positive surprises, but industrial companies are as well. Both sectors, in Europe and in the US, stand out in terms of inflows into ETFs this year. “European companies such as Siemens and Schneider Electric are active on a global scale and exposed to structural growth trends such as the energy transition, rising defence spending and the construction of data centres. In discussions with our clients, we have noticed that they are eager to capitalise on these opportunities.”
Energy is among the sectors with the strongest outflows. According to Chesworth, this is primarily due to declining oil prices, partly in anticipation of a possible end to the war in Ukraine and Trump’s election promise to pump more oil and gas and to halve energy prices.
Another important trend that the equity strategist observes is the performance disparity between European and American smallcaps. Smaller American stocks have demonstrated strong outperformance this year, while there has been little movement in the European smallcap segment. “The European economy is still in the early stages of recovery and investors are waiting to see further developments before taking on more risk. If the valuation gap between largecaps and smallcaps becomes too wide, it will likely attract more buyers,” Chesworth said.