According to Bloomberg, the value of European equities has fallen to the lowest level since 2004 when compared to their U.S. peers. The Stoxx Europe 600 Index trades with a book value of 1.43 versus a book value of 2.14 for the S&P 500. The reading on the Stoxx has been at least 30 percent cheaper than the S&P 500 for 69 straight days - the longest such streak since 2004.
The divergence between the two regions can be viewed in two ways. The European bulls will argue the divergence will narrow and therefore European shares will outperform those in the U.S. On the other side of the table the bears will argue the reason for the valuation gap is the future prospects of growth, or lack thereof. The U.S. GDP is expected to grow by 2.3 percent in 2012 compared with a contraction of 0.2 percent in Europe.
My personal view is that Europe is cheap. It is tough to argue with the numbers. If a mild recession occurs in Europe it will have an affect on corporate profits, however I believe that has already been priced into the market. Therefore, any uptick in growth or a resolution to the financial crisis should boost stocks in the region.
2 Major European ETFs to Consider
The largest ETF to cover the region is the Vanguard European ETF (VGK). With over $6 billion in assets and an expense ratio of only 0.14 percent the ETF is attractive for many individual investors. The ETF is made up of 458 stocks with the top ten accounting for 23 percent of the allocation.
The ETF is heavily invested in the U.K. (36 percent), followed by France, Switzerland, and Germany. The ETF has a price-to-book of 1.4 and trades with a P/E ratio of 11.1. Last year the ETF was down 11.5 percent, but through the first 20 days of January the ETF is already up 6.2 percent and at a new one-month high.
Its closest competitor is the iShares S&P Europe 350 ETF (IEV) that has $950 million in assets under management and a higher expense ratio of 0.60 percent. Similar to VGK, the ETF is heavily weighted in the U.K. (36 percent) and is followed by France, Switzerland, and Germany. There are a total of 357 stocks currently that make up the allocation.
The valuations are little richer for IEV with a price-to-book of 2.5 and a P/E ratio of 13.9. The 30-day SEC yield is 3.4 percent. Performance was nearly identical for IEV, losing 11.1 percent, slightly edging out VGK.
Based on the fact that the two ETFs are very similar in performance and composition it is a no-brainer to go with VGK. The lower fees and better valuations make that decision for me.
Even though I believe the European shares have a very high probability of outperforming the U.S. market in the next few months to a year it does not suggest to go overboard with the region. There are still many black clouds that hang over Europe that could send the valuations even lower. Remember that stocks that are cheap are attractive, but they can always get cheaper.