Why You May Want to Consider European Index ETFs

NEW YORK (ETF Expert) --The European Central Bank did not really surprise anyone with its well-telegraphed rate cuts on Thursday. Yet, risk assets of all shapes, sizes and geographic origins rallied a bit more than most had anticipated.

The reason? Not only did the ECB slash its overnight lending rate -- not only will they charge banks for depositing cash in ECB coffers (i.e. negative deposit rate) -- European authorities opened the door to unconventional asset purchases in the future.

Unconventional measures. Emergency stimulus. Quantitative easing. Whatever one chooses to call it, the ECB may eventually take pages from the scripts of Japan and the United States; that is, it may print money electronically and purchase market-based securities to stimulate economic activity.

Back in April, I suggested the ECB would ultimately agree to create euro-dollars electronically for the purpose of purchasing bonds and depreciating the euro-zone currency. (See Weaker Euro Presents ETF Admirers With Multiple Opportunities.) Many commented that Germany would never agree to such actions. Six weeks later, however, the probability of a QE-type intervention is increasing.

What does that mean for risk taking in general? At least for one trading session, it meant that investors would return to the riskiest areas of all. Micro-caps, small-cap growth, banks, biotech, alt energy and the Internet. High-flying momentum shares that had lost their luster over the last three months had recaptured the public imagination. After all, money from abroad can pour into U.S. assets just as easily as it can pour into European assets or emerging market assets.

Everything Risky Is Good Again?        
          6/5/2014   3 Months
First Trust NASDAQ Community Bank (QABA) 2.4%   -3.3%
iShares Russell Microcap (IWC)   2.4%   -8.4%
iShares Russell 2000 Growth (IWO)   2.2%   -6.8%
SPDR Biotech (XBI)       2.1%   -15.5%
First Trust Internet (FDN)     1.5%   -13.0%
SPDR KBW Bank (KBE)     1.3%   -2.1%
PowerShares WilderHill Clean Energy (PBW) 1.3%   -18.6%
Vanguard Extended Market (VXF)   1.2%   -1.4%
S&P 500 SPDR Trust (SPY)     0.6%   3.8%

In spite of former high-flyers regaining some of their momentum from 2013, I would rather add foreign equity exposure to client portfolios here in 2014. The trailing 12-month P/E ratio for iShares MSCI EAFE Value (EFV) hovers near 13. The S&P 500 SPDR Trust (SPY)? 18. What's more, EFV serves up an approximate yield of 3.1% versus 1.8% for SPY.

EFV 50 200
Another reason to shift to "value," particularly abroad, is the recent underperformance by consumer discretionary stocks. Stagnant wage growth coupled with the rapid decline of workers in the workforce is a signal of an unhealthy reliance on credit; the U.S. Federal Reserve may be losing its ability to persuade Americans to borrow and spend at exceptionally low interest rates.

In truth, consumers may already be pulling back on their purchases. After all, if middle class Americans were genuinely feeling good about the direction of the economy, you would not see so many retailers (e.g., Wal-Mart (WMT), Home Depot (HD), etc.) struggling to generate revenue. While one could make the case that tapped-out consumers could foreshadow a recession and/or bear market in stocks, it would be quite the leap to claim that a "consumer discretionary bubble" will shock the S&P for a 50% catastrophe.

Whether the smart money is exiting XLY due to overvaluation concerns, fears of a consumer credit bubble, or business cycle rotation, the money is moving just the same. The beneficiary? Foreign equities. The best way to play it safer is to diversify across the international value landscape with an index fund like iShares MSCI EAFE Value (EFV). 

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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