A big storyline heading into 2018 is whether this year’s strong performance in European equities will continue in the year to come or if it was merely a flash in the pan for an otherwise dysfunctional economy.

While there are potential headwinds for the recovery (namely, ever-present political risks and the challenge of negative interest rates for a banking system still confronting issues around deleveraging balance sheets while managing portfolios of nonperforming loans), there is also an argument that these risks are sufficiently priced in and this European rally is just getting underway.

For over 11 years, WisdomTree pioneered a proprietary, self-indexing approach to tap into markets in unique ways using a consistent, rules-based manner. A review of the WisdomTree Europe Domestic Economy Index’s construction provides interesting insights for how it benefited from the strong economic growth environment in 2017 and how it is positioned currently should this rally continue into 2018.

On Cyclical Growth

The WisdomTree Europe Domestic Economy Index is designed to represent a pure play on the more local dynamics of the eurozone economy. Many investors often are forced into small-cap companies to avoid large-cap mega-nationals that often are driven by global sentiment, China and the emerging markets. The WisdomTree Europe Domestic Economy Index was designed to be all cap, but it targets sector exposures that benefit from more cyclical changes in growth.

With European growth turning more positive in 2017, the Index’s 31.7% year-to-date returns have outpaced the MSCI EMU Index by over 400 basis points (bps).1 How was this outperformance achieved?

The Index’s methodology has four ways to target eurozone companies most sensitive to the local economy’s growth: