The Euro zone saw a strong start to the year thanks to economic improvement, rising inflation and the end of earnings recession. The Eurozone economy grew 0.4% sequentially in Q4 of 2016, in line with market expectations (read: ECB Trims But Extends QE: ETF Winners & Losers).

Recovering Fundamentals

Consumer prices in the Euro area are expected to rise 1.8% year over year in January of 2017, following a 1.1% uptick in December and surpassing market expectations of 1.6%. This represents the highest inflation rate since February 2013, thanks mainly to an energy sector rebound following the OPEC output.

The Euro zone expanded faster than the U.S. in 2016 for the first time since 2008. The European Commission’s economic sentiment indicator, a gauge of consumer and business confidence, was at about a six-year high in January, as per an article published on Wall Street Journal.

If this was not enough, the European companies logged their first increase in earnings in four years. Per Wall Street Journal, the earnings growth was because of improving corporate health. This along with cheaper valuation thus helped European stocks to fare better. Vanguard FTSE Europe ETF (VGK has added about 4.1% so far this year (as of February 17, 2017).

Solid Corporate Earnings

About half of the companies in the blue-chip Euro Stoxx index registered a 5.1% uptick in earnings year over year in Q4, revealed by FactSet. That reflects “the first annual rise since 2012, and the strongest in five years,” as per Wall Street Journal.

Investors should note that the Euro Stoxx index gained about 17% in dollar terms in the past four years, a period when the S&P 500 advanced 65%. Euro zone earnings per share are still about a fifth less than 2011, and a third less than the peak reached in early 2008.

A commodity market bounce and turnaround in the financial sector were behind the earnings improvement. BAML now expects 11% earnings growth in European stocks this year compared with 9% in the U.S. while for 2017, European shares are expected to see an 8% jump versus a 6% advance in the U.S. earnings.

Inside the Turnaround in Financial Stocks

Financial services are performing better lately as interest-rate expectations have gained momentum. And financial stocks are known to perform well in a rising rate environment. The Stoxx Europe 600 Banks Index has reached an almost one-year high.

Several banking earnings came in favorable. The Spanish banking behemoth Banco Santander, the Swiss giant UBS Group AG, German Deutsche Bank AG, Spain’s second-largest bank by market value Banco Bilbao Vizcaya Argentaria and Dutch lender ING Groep came up with assuring results in the latest reporting cycle. Though banking giant HSBC's decline in profits came as a shock, growing strength in other entities calls for some optimism.

With this, a turnaround in European banking shares can be expected as the space was troubled by elevated nonperforming loans across the Euro zone mainly in Italy and was thus sold-off. Also, skepticism over the health of Deutsche Bank and its ability to pay huge potential fines for mis-selling mortgage-backed bonds before the financial crisis of 2008 created confusion in the space (read: European Financial ETF in Focus on Deutsche Bank Woes).

ETF Bets

Given this bullishness, investors can have a look at Euro zone ETFs at least for the short term. However, there is a downside risk because the Euro zone is slated for several key elections this year, which can alter the market momentum.

Still for interested investors, we have found three ETFs in the broad European space that have surpassed the broader Europe ETF VGK in the last one month (as of February 17, 2017) and are expected to perform well in the months to come (see all Europe ETFs here). 

iShares Currency Hedged MSCI Europe Small-Cap ETF

Investors should note that small cap companies generate the majority of their revenues from the domestic market. Moreover, they pick up faster than their larger counterparts in a growing economy. As a result, small-caps should be at the center stage in Europe.

This fund gives currency-hedged exposure to small companies in developed European markets. It charges 43 bps in fees and is heavy on UK (31.7%) followed by Germany (11.2%) and Sweden (9.26%).

WisdomTree Europe SmallCap Dividend ETF (DFE Quick QuoteDFE - Free Report)

This ETF provides exposure to the small cap segment of the European dividend-paying market. The fund charges 58 bps in annual fees from investors. Among countries, United Kingdom (25.9%), Sweden (15.3%) and Italy (11.4%) dominate the holdings list. The fund yields 3.83% annually (as of February 17, 2017) (read: Warm Up to These Europe ETFs This Winter).

BLDRS Europe Select ADR ETF

The fund looks to track the BNY Mellon Europe Select ADR Index. It is heavy on United Kingdom (47.5%), Switzerland (12.7%) and France (8.7%). It charges 30 bps in fees. The fund yields about 3.89% annually (as of February 17, 2017).

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