Investors shun European stock ETFs as economic outlook darkens

Underperformance and growing macro risks make European equities even less popular

ETFs that track European stocks are feeling the effects of a decades-long underperformance that is set to intensify as the continent’s economic outlook deteriorates.

European equity ETFs have seen outflows of $5 billion this year, according to data from Bloomberg Intelligence. In contrast, Europe-focused bond ETFs saw inflows of $9 billion in one of the most extreme divergences ever recorded between the two asset classes.

It comes as spiraling inflation and a deepening energy crisis grip the continent, which should prolong its long-term underperformance against the US stock market and push investors into assets seen as stocks. shelters.

Eurozone inflation hit a record high of 9.1% in August, driven by rising energy prices on the continent.

Markets have now priced in an interest rate hike of 75 basis points to 1.25% when the European Central Bank (ECB) meets later this week. Bank of America now expects three more hikes to 2.25% by June 2023.

Bond yields in the eurozone rose sharply last week after the news, with Italy’s 10-year yield rising above 4% on Thursday as the country finds itself in the midst of an election and a deepening energy crisis.

As a result, hedge funds lined up the biggest bet against Italian government bonds since 2008 at 39 billion euros, according to data from S&P Global Intelligence.

The country is particularly sensitive to rising energy prices, having hitherto relied heavily on Russian gas. Last week, its economy minister said its net energy import costs are expected to double to nearly $99.5 billion this year.

Investors have made their sentiment clear, withdrawing $557 million from Italian equity ETFs and $175 million from fixed income ETFs since the start of the year, despite many bond markets seeing inflows.

For example, German bonds saw inflows of $978 million year-to-date, followed by the UK ($581 million), Switzerland ($164 million) and France ($142 million). millions of dollars).

Europe’s flagship bond market, the German Bund, saw some of the biggest swings in a decade in August ahead of ECB rate hikes.

Conversely, European stock markets faced large outflows, with ETFs following the German stock market seeing outflows of $655, while France and Spain saw outflows of $480 million and 156 million dollars, respectively.

Jose Garcia Zarate, associate director of passive research at Morningstar, said: “The first half of 2022 has been terrible for equity markets, so it’s no surprise to see some European investors pull back and rebalance their portfolios in favor of the perceived security of fixed securities. Income.

“Furthermore, the rise in bond yields, driven by rising interest rates, likely prompted investors to return to bonds.”

Is Europe in danger of falling out of favor?

While the current market outlook is troubling for European equities, it was the decade-long underperformance versus the US that has investors questioning its relevance.

So far this year, 27% of Europe-focused ETFs have beaten the iShares MSCI World (URTH) ETF while 22% have outperformed the SPDR S&P 500 (SPY) ETF, according to Bloomberg Intelligence. Over the past decade, the S&P 500 index has returned 246% while European strategies have gained 71% on average.

These lackluster returns have already seen European ETFs fall out of favor with US investors. No ETFs tracing primarily European equities have hit the US market since 2018, while 37 have closed in the same period.

Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, said: “Most ETFs closed in 2020 when several issuers inactive versions hedged against currency risk. However, the loss of interest in European ETFs stems in part from their general underperformance.

In the United States, redemptions of European strategies exceeded $10 billion year-to-date, losing $7.3 billion on a rolling three-month basis, their worst streak since 2016.

Garcia Zarate added that US investors will only view Europe as a tactical call generally correlated to US equities, while the current inflationary environment in Europe means there is no “compelling reason to price it in.” in his wallet.

“Temporarily, Europe will have fallen out of favor,” he said. “The short-term outlook for the European economy is not bright. War, threats of energy cuts, depreciation of the euro and the pound sterling, this is not the best publicity.

Detlef Glow, head of EMEA research at Refinitiv Lipper, said he believed the strong growth environment of the past decade meant Europe had lost a lot of ground to US equities.

“One of the reasons for this could be that Europe is seen as the ‘old continent’ with only a limited number of real growth companies compared to the United States,” he said.

“In combination with the assumption that the US will grow faster than Europe, this could be why European investors preferred to invest in US equities over European equities.”

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