An oft-repeated concern we hear from our clients is that as we enter the eighth year of a bull market cycle, U.S. equity markets have become expensive. When we think about consulting on portfolios for our clients, finding ways to reduce overall valuations is always near the top of our list of priorities. Right now, one-way investors can reduce equity portfolio valuations is by increasing allocations to overseas stocks. 

While recent months have seen flows go into emerging market and Japanese exchange-traded funds (ETFs), investors largely seem to be neglecting European stocks. This trend has continued from 2016, when European equities were among the most unloved asset classes, with over $23 billion in outflows for the year.¹ 

Performance of European Stocks Has Been Better Than Expected

However, outflows from European stocks may not have been justified by their performance. The WisdomTree Europe Hedged Equity Index, which focuses only on dividend-paying exporters, very quietly had a strong 2016. The index returned 9.99%, in perhaps the most overlooked year of near double-digit returns imaginable. This performance may be a surprise to many given the level of outflows from Europe ETFs over the last year.

In a way, the Index’s 2016 performance indicated a longer-term trend. The WisdomTree Europe Hedged Equity Index was launched in July 2012. Since then, the Index has returned a cumulative 79.7%—nearly as much as the S&P 500’s 84.4%.² Given client concerns about valuations in the U.S. markets (as each of the four major U.S. equity indexes have reached new all-time highs in the past few weeks), one may think that this sustained run of strong performance from the WisdomTree Index would also lead it to have lofty current valuations. However, this is far from the case.

Valuation Opportunities Emerging in Europe, but Not Everywhere

Since its inception, the WisdomTree Europe Hedged Equity Index has traded at an average of a 4% discount to the S&P 500.³ As of January 31, 2017, with the S&P 500 trading at a 21.6x price-to-earnings (P/E) ratio, the WisdomTree Europe Hedged Equity Index is only trading at a 16.7x P/E ratio, a 23% discount. This valuation gap is close to the largest it has been since the Index has existed.