Recession Risk Is Real For Eurozone ETFs

Long disappointing and downtrodden, eurozone stocks and the corresponding exchange traded funds are rebounding this year.

As Feb. 5, the iShares MSCI Eurozone ETF EZU and the SPDR Euro STOXX 50 ETF FEZ are up an average of 7 percent year-to-date.

What Happened

While 2019 is still in its formative stages, the starts to the year by EZU and FEZ are undoubtedly impressive following an average 2018 loss of just over 17 percent for the funds, which are two of the largest U.S.-listed eurozone ETFs.

As previous eras of upside for eurozone equities have taught investors, regional risks linger and continued upside for EZU, FEZ and rival ETFs this year may not be easy to come by.

Recession talk has been a familiar eurozone refrain for several years, and some data points seem to confirm that at least some of the region's economies are on the cusp of economic contraction.

Why It's Important

“Driven initially by a slowdown in exports, eurozone growth weakened markedly through 2018, culminating in a 1.2-percent year-over-year increase in GDP in Q4, the weakest pace of expansion in almost five years,” according to IHS Markit.

Growth in Germany, the region's largest economy, is expected to slightly outpace that of the broader eurozone. EZU devotes 27.54 percent of its weight to German stocks. FEZ has a 27.63-percent weight to Germany.

“A positive effect from fiscal stimulus measures in Germany, France and Italy has also been factored in,” said Markit. “But even with a decent start to this year, we forecast a significant slowdown in annual eurozone GDP growth in 2019 and 2020 to 1.2 percent and 1 percent, respectively, based on our preliminary estimates for February's forecast round.”

France and Italy are the eurozone's second- and third-largest economies, respectively. France is by far the largest country weight in both EZU and FEZ.

What's Next

There is also the issue of volatility with eurozone equities and funds. In every year from 2013 to 2018, the iShares Europe ETF IEV, a diversified Europe fund, was less volatile than EZU and FEZ. Rising eurozone recession risk would likely prompt an uptick in equity market volatility there.

“The key medium-term risk to the eurozone from an external perspective is probably a hard landing for the global economy, given the unusually long U.S. economic expansion currently and policy challenges, on the fiscal side particularly. China's rebalancing is an additional concern,” according to Markit. 

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