PowerShares: A Hedged Solution For Europe

November 09, 2015

[The following "ETF Issuer Perspective" is sponsored by Vident]

The eurozone economy has shown signs of improvement in recent months. The cyclical upswing is illustrated by the Markit Eurozone manufacturing PMI slowly rising from its November 2014 low of 50.1 to 52.3 in October 2015, and the October European Commission Manufacturing Confidence increasing to its highest level since 2011 at -2.0. Moreover, the EZ Service PMI has been at 54.0 in recent months1 and has lifted comfortably above its 51.1 November 2014 low, indicating that the expansion is broad-based. The tail wind of a weak euro currency, easy monetary policy and expanding economic indicators are benefiting the profit outlook for eurozone stocks. In fact, the MSCI EMU Index is expected to see profit growth of 8.2% in 2016.2

Although the outlook for eurozone profit growth is favorable, the view is known in the marketplace as the forward PE, and that and price to EBITDA ratios for the MSCI EMU Index are near 10-year highs at 15.60 and 6.88, respectively. Rich-looking valuations, coupled with lingering questions over the health of global growth, may make low volatility stock selection attractive for investors looking for eurozone exposure. The global economy is still on soft footing. Growth indicators from key emerging market economies such as China, Brazil and Russia remain weak, while the U.S. manufacturing sector is fragile given the October ISM manufacturing PMI of just 50.1.

Beyond valuation and growth risks, there is also currency risk for foreign investors holding eurozone shares. U.S. and European monetary policies are divergent, creating an environment for a strong dollar. The ECB is in the middle of enacting quantitative easing, and ECB President Draghi left the door open to additional action after the Oct. 22 ECB meeting. In contrast, the Fed is tilted toward tightening monetary policy and looking for an excuse to lift rates from crisis levels. Aggressive monetary ease by the ECB has pushed German two-year note yields into the -30 bp area, while the Fed’s tilt toward monetary tightening has pushed U.S. two-year yields toward 75 bps.3 The widening interest-rate differential is putting upward pressure on the dollar and providing investors with a reason to avoid the euro currency. To mitigate foreign exchange risk, investors may want to look at currency-hedged ETFs.

The PowerShares Europe Currency Hedge Portfolio (FXEU) may provide a solution for investors looking for exposure to eurozone equities but who are concerned about expensive European equity valuations and the threat of a decline in the EUR/USD exchanger rate. Its low-volatility stock selection methodology may provide upside participation and downside protection working to mitigate equity risks, while its currency hedge helps to protect investors from foreign exchange volatility and losses related to currency exposure.

1 Markit Economics press release Nov. 2, 2015
2 Bloomberg L.P.
3 Bloomberg L.P.

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