Wall Street is inching closer to record highs, but uncertainty remains over when the Fed will cut rates and overvaluation. On the other hand, some foreign economies have shown improving trends recently.
Among countries with a high potential for outperformance, the euro area is noteworthy. Several factors are contributing to this improved outlook. First-quarter GDP data beat expectations, signaling a better-than-expected start to the year.
Additionally, inflation is approaching the European Central Bank's 2% target, and the ECB itself is poised to start cutting interest rates, signaling support for monetary policy. Let's discuss the positive factors in detail.
ECB rate cut almost certain
The latest minutes of the European Central Bank (ECB) suggest that monetary policy is likely to be implemented in June. Most members supported keeping interest rates unchanged for now, but some members were already calling for a rate cut in April.
Minutes of the April meeting revealed that financial markets are bracing for a possible rate cut in June if future economic data is in line with current expectations. ECB President Christine Lagarde expressed a similar positive outlook, asserting that the eurozone economy is on track for recovery.
Lower inflation and improved euro area growth prospects
According to preliminary figures, the euro zone's annual inflation rate remained at 2.4% as of April 2024, in line with market expectations. Core inflation, which excludes volatile food and energy prices, was 2.7%, down from 2.9% in March.
Analysts in a recent Bloomberg poll revised their forecasts for the eurozone economy, expecting it to expand more rapidly in 2024 than previously predicted. The latest consensus suggests output in the 20-nation monetary union will rise by 0.7%, up from previously expected 0.5%. The upwardly revised forecast reflects more optimistic sentiment in the region.
Signs of improvement in Germany's sluggish economy
Of note, the GDP growth rate of Germany, the eurozone's largest economy, is now expected to be 0.2%, an upward revision from the previous forecast of 0.1%. Germany's economy expanded by 0.2% in the first quarter of 2024, beating market expectations for a 0.1% increase after contracting by 0.5% in the previous quarter. According to Trading Economics, the economy contracted by 0.2% year-on-year and entered a technical recession for the first time since 2020-2021. Furthermore, positive revisions were also seen in France, Italy and Spain.
Against the backdrop of improved corporate profits
As cited by CNBC, UBS said a weaker euro and higher PMIs are expected to push up European earnings revisions. “European profit margins (importantly, excluding financials) have grown much less rapidly than in the US, and 67% of the US profit margin improvement is due to unsustainable factors (low interest rates and tax cuts). compared to just 3% in Europe,” the strategists said. I have written.
lower valuation
S&P500–base fund SPDR S&P 500 ETF Trust (spy – Free Report) is up 26% over the past year; Vanguard FTSE Europe ETF (VGK – Free Report) rose 9.4%; iShares MSCI Eurozone ETF (Ezu – Free Report) increased by 12.9%. Fund SPY's P/E ratio is 17.86 times, and VGK's P/E ratio is 13.00 times. Fund EZU's PER is 13.23x. Eurozone ETFs are likely to fare better than the U.S. market if valuations become cheaper as monetary policy easing becomes a reality.
Furthermore, as quoted by CNBC, UBS pointed out that the so-called equity risk premium (ERP), or the excess return on equity investments compared to risk-free alternatives, is much higher in Europe than in the US. . UBS also highlighted that Europe's ERP is 2.1 percentage points ahead of the US, near an all-time high.
Featured ETFs
Against this backdrop, investors can track Eurozone ETFs such as: iShares MSCI Denmark ETF (eden – Free Report) (up 4.4% last week), Franklin FTSE Germany ETF (FLGR – Free Report) (up 2.4% last week), iShares MSCI France ETF (EWQ – Free Report) (up 2.3% last week), iShares MSCI Austria ETF (EWO) (up 2.3% last week), SPDR EUR STOXX 50 ETF (Fes – Free Report) (up 3% in the last week) and iShares MSCI Eurozone ETF (Ezu – Free Report) (up 3% last week).
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