ETF Edge - Going Global: Red-Hot Flows into European ETFs 4/24/23

Episode Date: April 24, 2023

CNBC’s Bob Pisani spoke with Matt Bartolini, Head of SPDR Americas Research at State Street - along with Vance Barse, Founder of Your Dedicated Fiduciary. As the Euro Zone recovery gathers steam, European markets have been just crushing it. Our panel of experts explored the strength behind the red-hot flows pouring into European ETFs so far this year. Luxury names, in particular, have enjoyed huge rallies - but what about other sectors? What's driving so many of these major European ETFs to new highs - and how sustainable is this momentum? In the “Markets 102” portion, Bob continued the conversation with Vance Barse from Your Dedicated Fiduciary.  Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, ETF Edge is going global as the Eurozone recovery gathered steam. European markets have been.

been crushing it. We'll go deep with our panel of experts and explore the strength behind the red hot flows pouring into European ETF so far this year. Luxury names in particular have enjoyed huge rallies. But what about other sectors? What's driving so many of these major European ETFs to new highs and how sustainable is that? Here's my conversation with Matt Bartolini. He's the head of Spider, America's research at State Street, along with Van Svars, founder of your dedicated fiduciary, here to give us the RIA, respect. Matt, all the major European ETFs are up 15 to 20% for the year, and we're at new highs last week, including your own stocks 50 ETF. That's up 20% this year.

Give us the lowdown. Why is Europe doing so well this year? Well, when we look at it from a few different factors, particularly quantitatively, we see that fundamental valuations are supportive. You know, relative valuations relative to the eurostock's own history or towards the S&P 500 or, Act, we are constructive. They're trading in a larger discount than normal. So those valuations were attractive for investors to step into as the year started. And those healthy valuations were also being met with actual earnings upgrades. So we've actually seen earnings for 2023, four European firms actually increase. And that's completely different than what we

saw for U.S. firms. We've seen U.S. earnings be downgraded. So you have those two factors at play, valuation and sentiment. Those are both pointing up for European markets. and then throw in some strong price per momentum. And those are three quantitative factors that are adding support to this rally and the interest we've seen from investors so far in the ETFs. We've seen a significant amount of inflows into those European-focused ETFs. And look at these returns here. And these are broad European ETFs, including your own, Matt, FeZ, there right at the top of 20%. Now, a lot of people like to say that this is just luxury stocks.

And it's true, LVMH, for example, and rolls. Royce and a lot of these luxury stocks have far outperforms. Some of them are up 20 to 40%. But when I look a little deeper, even the consumer stocks, everyday consumer stocks, Adidas is up 20% or more. Bear is up 20% or more. So here's some of your luxury names that are moving. But look at some of the other ones that are out there. Adidas, Bear, SAPs, Dilanthus. They're all having a good year as well. So I guess my point here, Matt, is it's true that luxury is doing well because They sell to China, which is reopening, but there's really a broader story going on. You can't just say it's, oh, it's just luxury.

That's right. When I was discussing those metrics earlier, that's on a broad-based level. So the market itself was being attractively valued, and the market itself was seeing earnings revisions move to the upside. So from an investor's relative positioning perspective, you have attractive valuations and positive earnings sentiment overseas in a much more stronger fashion than you do relative to the U.S. We've seen investors make that relative positioning perspective by going overweight European equities

and using the capital from sales within the U.S. So basically, buy Europe and sell U.S. has been some of the trade that we have seen. Vance, I want to bring you in here. You know, we were discussing this six to eight months ago, Matt and I and a bunch of other people, and the consensus at that time, late summer of last year, was the war in Ukraine was going to have a very negative effect on European earnings and valuations. But I don't want to downplay that horrible situation over there. But how is that perception changed? It seems to be very different now, six, eight months later. 100%. I think that the collective investor psyche has gotten used to

the war in Ukraine being an ongoing item, if nothing new. Now, at its outset, there was a very strong risk off trade idiosyncratic to Europe because it was the first armed conflict that we have seen in Europe in decades. When we look at valuations and to echo some of Matt's thoughts, historically the euro trades at about a 15% discount to U.S. valuations. Now, they're currently about 30% at a discount relative to the U.S. So I think that there is some optimism that that that spread could narrow as we see things like the ECB projected to cut rates starting in early 2024, hopefully some peace and resolution comes to the war in Ukraine. And also, of course, China reopening, which bears no explanation given its role in global

trade and distribution. Yeah, I think, Vance, people need to understand how important what you just said was about the relative valuations. and particularly Europe trading as a value proposition. So traditionally, if Europe trades at 15 times forward earnings, and now it's at 14, well, there's a little bit of a discount. But the United States traditionally would trade, pick a number 17, and it's close to 19 now.

I mean, that's a big spread. 19 versus 14 is a huge spread. It's a, as you mentioned, almost a 25, close to 30 percent difference. So that's very unusual that spread, but also the fact that it's trading on a market. a very relatively high value basis would make it attractive independently of whether there are other things going on. So you've got to, I guess Vance emphasized the fundamentals here of what's going on, that there's

a relative value proposition here. Yeah, very much. So, you know, Bob, when we look at U.S. growth, it has been slowing because of where the Federal Reserve is in the rate hike cycle. We have not seen the same level of rate hikes over in the state hikes over in the federal reserve. the Eurozone as it relates to the ECB. So there's some fundamental factors at play here that can certainly help explain the year-to-date performance that we have seen of European markets, particularly in a luxury goods section. You know, one of the things that I was reviewing

prior to the show is the decrease in the cost of Nat gas. Naturally, with winter coming here in just a few, pardon me, short months, we anticipate that the cost would go up. But it's been a pretty significant sell-off this year in terms of the cost, which could arguably be a tailwind for the European consumer to help spend on those luxury goods. You know, that's a good point that we had that was just made there. Matt, everyone was concerned about the price of natural gas and the price of heating, and it didn't happen. We had a relatively warm winter, not just in Europe, but in the United States, for whatever reason.

Is that not a major factor as well here? We just had favorable climate situation. Yeah, I mean, at the start of, you know, or middle, middle of last year, there was probably more of an overhang than anything else. That's a pretty negative sentiment about what the energy crisis could do for forward-looking growth expectations. And the fact that you did have a warmer winter, and perhaps there was some stock piling built up in terms of the energy that could be consumed,

those fears are obviously going to be lesser now. And so that overhang that was, you know, weighing on some of the sentiment is obviously gone. And that has released some optimism into the European market. And we're starting to see investors come into that because there are more things pointing up than there are more things pointing down for the European markets. Yeah. And I want to go back, advance, to earlier points that we're making about why Europe is outperforming. We talked about the relative valuations.

But another key point, the madame made earlier, was earnings are rising. So in the United States, generally earnings estimates are going down. They've been going down for the first and second quarters. But earnings estimates are rising over in Europe. On top of that, we also have a weaker dollar. So there's several factors here besides relative valuation that are really becoming very important. Why are earnings rising overall? A number of factors, the first of which is fundamental.

If you look at unemployment relative to where it was a few years ago, that has improved. The forward rate hike path for the ECB is projected, believe it or not, to see an actual cut in Q1 of next year. Obviously, anything can happen. The level of inflation, so year over year, is anticipated to drop from its current level down to three points. percent again year over year in the fourth quarter of this year and then hover in that high two percent range the first half of 2024 naturally that gets us closer to the ECB's two percent target and we also have to consider the fact that there are currency plays of foot here the euro is weaker than the dollar so if we look at the disproportionate effect of profitability in

manufacturing items in the euro, selling them in dollars, and then bringing those profits back in the euro, those things are all serving as tailwinds. Yeah, and Matt, I want to go and emphasize the dollar here because this can be very important when you translate profits from one currency to another, you can get a big difference. Tell us why the dollar has been weaker recently. I mean, it seems to me the obvious answer is the Federal Reserve has been hiking rates much more aggressively than the European Central Bank. Is that correct? Is my assumption correct? And is there anything else going on here? Well, at the end of last year, the dollar was trading in

basically 20-year peaks. And that was, you know, far too high. So we've seen the market recalibrate their expectations for what the dollar would be trading at. And the dollar has come off of those peaks. And part of that is that the Federal Reserve was massively aggressive in 2022. and they signal to the market that will be less so aggressive this year. So that, you know, sort of interest rate parity type of valuation metric is no longer, you know, significantly increasing the dollar. So we've seen the dollar come off of its peaks, starting to decline. Meanwhile, the euro has strengthened as a result of that dollar's weakness.

And I think in our team, our currency team's view is that the dollar could materially weaken further as the Federal Reserve, again, really slows and potentially, you know, cuts. starts cutting rates as well. Yeah. You know, so the important thing here, folks, is a strong dollar makes imports cheaper and exports more expensive and vice versa. And it can dramatically affect earnings situations. In fact, big multinationals like Procter and Gamble routinely will have a paragraph in their

earnings report about the influence of currency. So the point is here, the weaker dollar is a headwind. excuse me, a tailwind for Europe and European companies. I want to just talk about relative outperformance, reversion to the mean, statistical portion of the show. Europe, Vance has underperformed, I mean, dramatically underperform, for 10 years.

I think we have some charts here. The S&P 500 is up 260% in the last 10 years. The stock 600 is up a little more than half. There you go. Thank you. The stocks Europe's 600, which is sort of the S&P 500 of Europe, is up 158%. That's a lot, folks. So you're wondering, is that statistically significant?

Yeah, that's a huge difference. So I guess, Matt, some mean reversion would be, there's your chart. There you can see it. The white is the S&P and the orange is the Europe Stocks 50, which is similar, but a little smaller than the 600. You get the idea here. I guess some mean reversion is appropriate at this point. Independently of, you know, Ukraine and all of that, some mean reversion is almost inevitable, right? Yeah, that's correct. I mean, at the end of 2022, international developed ex-U.S. stocks had underperformed the U.S. or the S&P 500 for 55 consecutive rolling 12-month periods. That was almost a record.

And then December 2022, non-US equities finally beat U.S. equities. So there's a little, you know, changing of the tides or turning of the tides here where we're starting to see leadership emerge outside the U.S. I think part of it is just those valuations. After, you know, many years of underperforming, those valuations are attractive. And we have seen U.S. equities become, you know, relatively priced for perfection, which, you know, obviously is quite different than the Europe, where there's some value to be extracted. Yeah. Let me, Vance, do you have any other observations on the rest of the world? We're focusing on Europe here because the European country stocks and a lot of European luxury stocks hit new highs last week. So that's, we noticed that here at CNBC. But Vance, what about the rest of the world? You see anything interesting going on in Asia, in South America? You know, we tend to be very U.S. focused here in the United States. And we have an opportunity to sort of talk about global. movements. Anything outside of Europe that strikes you of interest? Yes, specifically, Bob, emerging markets have really caught our rise,

simply because as we anticipate the dollar potentially weakening in the future, we believe that that could be a tailwind to emerging market currencies and other currencies. And so we have ratcheted up a bit. The allocation that we have to emerging markets really is. part of the overall increase that we have made to international markets. We are not solely married to international developed markets like Europe. We do like to differentiate the different parts of the globe, if you will, and also the sectors therein. So we have not only in addition to increasing allocations to Europe, we have also looked at emerging markets, particularly as it

relates to currency play. And we're seeing asset flows demonstrate that. Look at the year-to-date moves, not only in performance, but an asset flows across the globe. And you look at the outlook in the U.S., relative to the rest of the world, particularly in light of monetary policy. And clients are bringing this up day in and day out. Where's the opportunity? We want to be there. Yeah. Matt, how about you? Vance like emerging markets. Any other parts of the world that are interesting to you? Well, I mean, emerging markets is sort of the same idea from a valuation perspective. Sentiment isn't as strong in EM from an earnings perspective.

So for that reason, it's still rather stay in non-developed ex-US equities. So you think EFA, stocks, you know, there's less geopolitical risk there than there is over in emerging markets. So for that reason, sort of staying in those developed areas, I think is something that we keep on having discussions with clients. just because there is constructive valuations, positive earning sentiment, and to a degree, less macro risk than when viewing it versus emerging markets. Yeah, I agree with that. I mean, the political risk gets very high these days, particularly with the conflict with China going on. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs.

This is the Market's 102 portion of the podcast. We'll be continuing the conversation with Vance Bars from your dedicated fiduciary. Vance, thanks for sticking around. We had this long discussion with you and Matt about Europe and a little bit about emerging markets. I wonder, as a guy who provides advice to people, what your outlook is for the rest of the year. What's astonishing to me is the market is positioned for a soft landing. The market seems to want to believe the valuations are really high, 18 or 19 times forward earnings. The earnings are not dropping dramatically.

They're down a little bit, but not dramatically. They're basically flat for the year. So the market wants to believe in the soft land, yet most people don't believe it. They're pessimistic. The strategists don't want to believe it, yet the market keeps holding up. What's your outlook for, what are you telling clients for the second half of the year? So I tell clients that data should drive decisions. And one of two people right now will likely be very, very raw.

Either the bond market, where the interest rate volatility seems to be hyperventilating through a paper bag, or the narrative of the Federal Reserve with respect to its rate hike path. It's going to be really interesting to see which of those two comes to fruition here back half of this year and transitioning into 2024. So tell clients that we should really manage our expectations and look at current markets and the environment in the lens of 2023, not the lens of quantitative easing, so-called QE, or, or the zero interest rate policy environments we had for 13 years, because that economy,

for now anyway, seems to have been put on the back burner because we now have a situation where interest rates are such that cash is no longer trash. We can get four plus percent in money market funds and T bills. We can get good quality bonds. And let's not forget that with the anticipated rate cuts of the Fed, whenever they may happen, that could serve as a windfall for the price and parity on bond funds. But you still haven't told me what you think is going to happen. You've got to stick your neck out a little more than that, Vance.

I mean, is the Fed going to cut rates before the end of the year or not? The market seems to be positioning for the Fed's going to maybe do one more rate hike, 25 basis points in a week or so, and then they're going to stop and suddenly magically decide either late this year or early next year to start cutting interest rates. If that doesn't happen, if inflation stays high, the Fed not only doesn't cut rates, but keeps them really high. I mean, there's certain sectors here like technology, I think, that are in some trouble right now. So what is it?

Are they going to do this or not? Are they going to cut rates or not by the end of the year? Well, I would love if my crystal wall would allow me to jump into the future and tell you. But when I explain monetary policy to clients, I'm outlining the fact that the Fed does at this point seem to be data-dependent and that we really should look at equity allocations with a barbell approach because the fang and t trade, if you will, that really led markets. And to some extent this year, we've seen the same thing, but it led markets for the 13 years. I think that that will come back into play when the Fed cuts.

Now, to very specifically answer the question, Bob, if we see another big bank fail, if we see economic data absolutely fall through the floor, I think that the fed's likely to cut back half of this year, early 2024, but I really do believe that the Fed is going to cut one more meeting. I'm sorry, raised, pardon me, one more meeting, and then wait and see what happens. And that's why we have not let go of a lot of the high-quality, dividend-paying ETFs and individual equities that we have in. So what do you like for the rest of the year?

Or what do you think, rather than what you like, what do you think, the market's going to like. We heard last year, dividends did really well, dividend paying stocks did very well. The word quality came up a lot of times from the second half of the year and into the first quarter of this year. Quality is basically momentum with improving earnings, it seems to me. Is that a reasonable bet for the rest of this year? I would think so. And we've also, believe it or not, been pretty pro on fixed income. So if we look at bond ETF, bond mutual funds or high quality individual issues, given the anticipation that the Fed will eventually cut, if we have an average duration of, say, six or seven years, there's the potential to make

money on par as interest rates come down because if we do go into that hard landing scenario of versus what we've been doing, which has been rolling treasury bills for about the last year or so, we want to try to position the portfolio to take advantage of that potential drop in rates and make money on par. All right. We're going to leave it there, Vance. Very much appreciate you joining us. Everyone, you've been listening to the Vance Fars. He's the founder of your dedicated to do sherry. And thank you, everybody, for listening to the ETF Edge podcast. InvescoQQQQ believes new innovations create new opportunities.

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