For virtually the entire post-pandemic environment, European equities have been historically cheap relative to U.S. stocks.

This is not surprising. In the nearly four years since the end of 2020, U.S. markets have been propelled by the eminent Magnificent 7 and other beneficiaries of artificial intelligence, resulting in 13.8% annualized gains for the S&P 500. Valuations followed suit, climbing to their highest levels since the throes of the pandemic and inspiring debate about what constitutes a “fair” multiple for the index amid rapidly changing sector and fundamental composition.

Meanwhile, Europe was mired in a low-growth environment with an absence of innovative technology companies to pique the interests of global investors fixated on the U.S.

Today, the U.S.-Europe equity disparity has culminated in the cheapest relative valuations we’ve ever seen. Forward price-to-earnings (P/E) multiples for the MSCI EMU Index (European Economic and Monetary Union) compared to the S&P 500 are more than two standard deviations below their long-term median, where they have remained for over a year.

European Equity Valuations Remain Subdued Despite Economic Momentum

The valuation differential is finally intriguing Europe-skeptics at a time when post-pandemic U.S. equity superiority and subsequent market concentration is prompting diversification discussions. Discouraged by lofty U.S. multiples and underwhelming forward return expectations, equity allocators are beginning to consider European positions for the first time in recent memory.

For those newly considering international allocations, we recently rebalanced our suite of European equity Indexes in October.

These Indexes are intended to be broadly diversified and highly correlated to representative market cap-weighted Index variants.

• WisdomTree Europe Hedged Equity Index (WTEHIP): Provides exposure to dividend-paying European equities while neutralizing fluctuations between the euro and the U.S. dollar. Eligible companies must be domiciled in Europe, trade in euros, have at least a $1 billion market capitalization and derive at least 50% of their revenue in the latest fiscal year from non-European countries. The latter parameter gives the resulting stock basket a tilt toward exporters, and all companies are dividend weighted.
• WisdomTree Europe SmallCap Dividend Index (WTESC): Comprises the bottom 25% of the market capitalization of the European companies from another “parent” Index (the WisdomTree International Equity Index, WTDFA) after the 300 largest companies have been removed. Despite containing the bottom 25% of residual European market cap, its constituents are still dividend
• WisdomTree Europe Hedged SmallCap Equity Index (WTESEH): Provides exposure to European small-cap equities while neutralizing fluctuations between the euro and the U.S. dollar. The Index is a bit smaller than WTESC’s residual market-cap selection, as it comprises the bottom 10% of market capitalization of European companies traded in euros from its parent, the WisdomTree International Equity Index. Once again, the equity basket is dividend weighted.

Below we summarize some of the notable changes from the 2024 rebalance.

Country Exposures

In WTEHIP, there were no major changes between the pre- and post-rebalance country allocations. The Index retains a heavily over-weight allocation to Spain and to Finland to a lesser extent, and under-weight allocations to France, relative to the MSCI EMU. Under-weight allocations to France and Germany were a result of our Index’s 25% country exposure caps.

For WTESEH, the pre- and post-rebalance changes were also negligible. It has heavily under-weight allocations to France, Germany and the Netherlands relative to the MSCI EMU, which are partially offset by allocations to Italy, Belgium and Finland.

WTESC, which includes the U.K., has more pronounced changes resulting from its rebalance. Relative to the MSCI Europe Index, it has a more than 12% over-weight allocation to the U.K. and an under-weight allocation to Switzerland of the same size. It also has large under-weight allocations to France and Germany, which are partially offset by over-weight allocations to Sweden and Italy.

A Note on Export Exposure

The opportunity for Europe may be compounded as the attractive valuations discussed earlier coincide with additional macroeconomic stimuli.

The European Central Bank (ECB) is still in the early stages of monetary easing in an effort to stimulate economic growth. It has cut rates three times so far this year and more reductions are expected over the near term. Lower policy rates may weigh on the euro, which would make European-manufactured goods more competitive in the global marketplace.

This could benefit exporters, which is especially valuable as the current growth prognosis for the eurozone remains relatively weak.

With greater dependency on non-eurozone economies, exporters may receive a tailwind from Chinese stimulus and steady growth in the U.S.

Compared to the broader eurozone index, WTEHIP features greater international linkages. According to FactSet Geographic Revenue (GeoRev) data, the companies represented in WTEHIP receive about 26% of revenue from the U.S., where the economy remains rock solid. That’s about 7% more than the MSCI EMU, in aggregate.

In the emerging markets, the region’s revenue exposure is about 23%, compared to 29% for our Index. WTEHIP also sports a 1% revenue pickup in China. While small in amount, it could be beneficial as China continues to flirt with more economic stimulus. If Chinese stimulus measures disappoint, or if the economy continues to falter, its impact on WTEHIP would likely be modest.

Geographic Revenue Exposure

Sector Exposures

At the sector level, the only major changes stemming from the rebalance were to Consumer Discretionary within WTEHIP and to Industrials within the two small-cap Indexes, which are now all underweight their pre-rebalance exposures by about 4%–8%.

Relative to the MSCI EMU, WTEHIP and WTESEH both have considerable under-weight allocations to Information Technology and Consumer Discretionary, which are partially offset by over-weight allocations to Communication Services, Industrials and Materials. Compared to broader Europe, WTESC features larger under-weight exposures to Consumer Staples, Financials and Health Care, and over-weight exposures to Consumer Discretionary, Industrials and Real Estate.

Fundamentals

Our annual rebalance tends to make our Indexes even more appealing from a fundamental standpoint, and especially when compared to the market cap-weighted MSCI Europe. This year’s screening process was no exception. As a result:

• WTESEH and WTESC reduced their trailing P/E ratios by 3–4 points each, while increasing their dividend yields. These improvements also coincided with pickups in return on equity (ROE) and return on assets (ROA), which enhanced the quality profile of the Indexes. Relative to the MSCI Europe and EMU, these two stock baskets offer cheaper valuations with 1%–2% improvements in dividend yield and a comparable quality profile (which is an unusual benefit for a small-cap index relative to a predominantly large-cap one).
• WTEHIP slightly reduced its dividend yield, which now trails that of the MSCI EMU by about 40 basis points. Its trailing P/E also looks like that of the market cap-weighted index, but with a quality profile that enhances ROE and ROA and offers lower leverage.

For additional details on each rebalance, please visit the respective Index pages on the WisdomTree website:

• WisdomTree Europe Hedged Equity Index (WTEHIP)
• WisdomTree Europe SmallCap Dividend Index (WTESC)
• WisdomTree Europe Hedged SmallCap Equity Index (WTESEH)