Photographer: Simon Dawson/Bloomberg, Photo Illustration by Tom Hall

Draghi Spurs Bulls to Ditch U.S. Equities for Europe: Options

Equity investors are switching their allegiance to Mario Draghi from Janet Yellen.

Anticipation of more stimulus from the European Central Bank triggered a record amount of money into an exchange-traded fund that tracks the region’s stocks while hedging against currency moves. The Stoxx Europe 600 Index posted its best January since 1989, while the Standard & Poor’s 500 Index had its worst month in a year, with traders pulling more money than ever before from an ETF tracking it.

Optimism that the ECB will shower the financial system with cash has offset a rise in volatility stemming from a new Greek government and the Swiss National Bank’s surprise decision to scrap its currency cap. Now, after lagging behind U.S. shares for six years, it’s time for European equities to outperform, according to Michael Kapler of Mittelbrandenburgische Sparkasse.

“This is just the start,” said Kapler, a portfolio manager at the bank in Potsdam, Germany. “Europe has huge central-bank stimulus, the weak euro, lower valuations and solid earnings growth all working in its favor. You don’t really need too much more than that for a significant rotation into Europe in the next months, even with some periods of political risk.”

ECB President Draghi announced a $1.1 trillion ($1.2 trillion) asset-purchase program just three months after the Federal Reserve stopped a similar policy known as quantitative easing. Further weighing on U.S. stocks is the likelihood that the Fed will lift interest rates in 2015, Kapler said.

The Stoxx 600 ended little changed today, while the S&P 500 rose 0.3 percent at 12:47 p.m. in New York.

Exporters Appeal

European stocks rallied to a seven-year high, while bond yields slumped and the euro tumbled to its lowest level since 2003 versus the dollar. A weaker currency boosts the appeal of exporters, and lower bond yields make stock returns more attractive, says Gilles Guibout, a fund manager at AXA Investment Managers.

“There’s little room left to make money” in bonds, said Guibout, who helps oversee about $760 billion at AXA in Paris. “Many investors become starved for yield, and they have to go into equities.”

To gain exposure to European shares while protecting against a decline in the euro, U.S. traders put a record $2.9 billion into the WisdomTree Europe Hedged Equity Fund last month, data compiled by Bloomberg show. The ETF attracted about the same amount during the fourth quarter.

S&P 500 Drop

For the S&P 500, January played out differently. The benchmark gauge dropped 3.1 percent, ending the month 4.6 percent below its record in December. More than $28 billion poured out of an ETF tracking the index, following four straight months of inflows.

Not all European equities followed the Stoxx 600’s advance last month. Switzerland’s surprise decision to ditch its currency cap against the euro sent the Swiss Market Index down 6.7 percent. Roche Holding AG, one of the nation’s biggest companies, said the franc’s surge may strip 9 percentage points from growth in operating profit this year.

In Greece, the election of anti-austerity party Syriza reignited concern that the country will leave the 19-nation currency bloc. Banks led the plunge in the ASE Index, losing about 8.6 billion euros of market value in three days last week.

“I’m not totally convinced that QE will find its way into the real economy,” said Ros Price, chief investment strategist of Seven Investment Management Ltd. in London. “There are many geopolitical risks right now, and we’re just choosing to stick our heads in the collective sand. If Europe pulls the plug on Greece and the banks collapse, they’ll be sure to drag others down with them.”

Bright Spot

Profit growth is among the bright spots in Europe. Analysts estimate earnings at Stoxx 600 companies will jump 7.3 percent this year, more than the 3.4 percent increase for members of the S&P 500, according to the average projection compiled by Bloomberg.

And European stocks remain cheaper than their U.S. counterparts. The Stoxx 600 trades at 15.3 times estimated profits, about 8 percent below the S&P 500’s valuation.

“We don’t see much upside for U.S. valuations,” said Patrick Moonen, who helps oversee about $200 billion as a senior strategist at ING Investment Management. “The difference between the two markets has been remarkable year-to-date.”

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