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Europe has been dominating headlines over the past few months, with sentiments turning bullish lately. According to the fund manager survey by Bank of America Merrill Lynch, the recent stimulus efforts by the European Central Bank (ECB) have injected optimism into the continent, in particular the 19-member Euro zone economy.

The ECB announced a bond-buying program to pump €1.14 trillion ($1.16 trillion) into the sagging Euro zone over the next one and half years. It plans to buy €60 billion worth government bonds, debt securities issued by European institutions and private sector bonds per month through September 2016 (read: Europe ETFs in Focus after ECB and Swiss Action).

Of the managers surveyed this month, 51% believe that the European equity space is the best to park one’s money over the coming one-year period and 81% expect the European economy to strengthen, against 18% and 48%, respectively, in the January study. Further, a slew of positive economic indicators and a four-month bailout extension to Greece by international creditors raised hopes on the single currency bloc.

Solid Numbers and Bright Outlook

The Euro zone economy picked up 0.3% in the final quarter of last year with Germany proving itself a powerful engine once again offsetting the weakness in Greece and Italy. The growth rate was ahead of 0.2% growth in the third quarter and analyst expectation of 0.2%.

Business activity was also at a seven-month high in February buoyed up by robust domestic demand, as depicted by Markit’s Composite Purchasing Managers Index for Euro zone. The index jumped to 53.5 this month from 52.6 in January. Growth came from the manufacturing and service sectors with the latter seeing faster expansion.

All these suggest that the Euro zone recovery is gaining momentum and will likely accelerate in the coming months since cheap oil, a weak euro and cheap money flow act as major economic tailwinds. The European Union (EU) early this month raised its 2015 growth forecast for the overall European economy from 1.5% to 1.7% and for the Euro zone from 1.1% to 1.3%. The commission also expects the European economy to grow 2.1% and the Euro zone to grow 1.9% next year. Notably, for the first time in eight years, all the European countries are expected to grow in 2015.

Moreover, unemployment fell to the lowest level since August 12 to 11.4% in December from 11.5% in November. The EU projects Euro zone unemployment to drop gradually from 11.6% in 2014 to 11.2% this year and 10.6% in the next.

European stocks also appear cheaper at the current levels than the U.S. stocks. This is especially true as the stocks in the MSCI Europe Index are currently trading at 14.58 times estimated earnings for the next 12 months versus 17.1 times estimated earnings in the same timeframe for the S&P 500. Low valuations and a slew of positive developments are making us more optimistic on the European market (see: all the European ETFs here).

Deflation: A Cause of Concern?

Though lower energy prices are boosting consumer spending, it is raising deflationary pressures. Several months of decline in energy prices found Euro zone in deflation in December, for the first time in more than five years. Consumer prices fell sharply to 0.6% in January from a 0.2% decline in December.

However, deflationary fear is expected to ease in the coming months when ECB starts its bond-buying program in March. The EU expects inflation to be negative 0.1% this year, marking the first annual decline since the introduction of the euro in 1999, and then increase to 1.3% in 2016.

Given bullish fundamentals and recovering fundamentals, European stocks have been on a tear with the Stoxx Europe 600 index hitting the seven-year high. For investors seeking to participate in the recovery, a focus on top-ranked Europe ETFs could be a less risky way to tap the same broad trends.

Top Ranked European ETF in Focus

We have found a number of ETFs that have the top Zacks ETF Rank of 1 (Strong Buy) or 2 (Buy) rating in the broad European space and are thus expected to outperform in the months to come. While all these top ranked ETFs are likely to outperform, the following three could be good choices to tap into the space (read: all the Top Ranked ETFs).

The trio has enjoyed a strong momentum in the year-to-date period, and has potentially superior weighting methodologies which could allow it to continue leading the European space in the months ahead. Further, these funds have become extremely popular this year and have seen huge capital inflows. In fact, two of these offer protection against the sliding euro while simultaneously providing exposure to the European stocks.

WisdomTree Europe Hedged Equity Index Fund ((HEDJ - Free Report) )

Investors loaded HEDJ in their portfolio for exposure to European stocks while at the same time for a hedge against any fall in the euro. The fund, with an asset base of around $11 billion and average daily volume of about 2.3 million shares, has pulled in more than $4.6 billion in capital so far this year. It tracks the WisdomTree Europe Hedged Equity Index holding 124 securities with a heavy concentration on the top 10 holdings at 45.6% (read: ETF Asset Flow Roundup: Europe & Gold Gain, U.S. Lags).

However, it is pretty well spread across a number of sectors with consumer staples, consumer discretionary, industrials, health care, and financials taking double-digit exposure each. Among countries, Germany and France take the top two spots with at least 25% share each while Spain and the Netherlands round off the next two spots. Expense ratio came in at 0.58%. The fund returned about 14% in the trailing one-year period and has a Zacks ETF Rank of 1.

iShares MSCI EMU Index Fund ((EZU - Free Report) )

This product provides exposure to the EMU member countries (those European Union members that use the Euro as its currency) by tracking the MSCI EMU index. It has seen capital inflows of $765 million, propelling its total asset base to $8.7 billion while trades in a solid volume of around 7 million shares a day.  The fund charges investors 0.48% in annual fees and holds about 243 securities in its basket.

It is well spread across each security, as no single firm makes up for more than 3% of the assets. The product has a definite tilt towards financials at 23.1%, followed by consumer discretionary (14.4%), industrials (12.9%) and consumer staples (10.7%). From a country look, France and Germany takes the largest share in the basket with 32.3% and 30.3% share, respectively, while Spain, the Netherlands and Italy round off the top five. The fund has added over 7% so far this year and has a Zacks ETF Rank of 2.

iShares Currency Hedged MSCI Germany ETF ((HEWG - Free Report) )
    
This ETF targets the German equity market without the currency risk. It follows the MSCI Germany 100% Hedged to USD Index and is basically a holding of (EWG - Free Report) with currency hedged tacked on. Consumer discretionary dominates the fund’s return with less than one-fourth share while financials, health care, materials, and industrials also get double-digit allocation (read: 4 European ETFs to Buy on Cheaper Valuations, QE Launch).

The fund has gathered over $650 million in capital this year, taking total AUM to $818.4 million. Volume is good as it exchanges nearly 418,000 shares on average daily basis. It charges 53 bps in annual fees and has added 13.7% this year. HEWG has a Zacks ETF Rank of 1.

Bottom Line

Given the current trends and increasing confidence in the Euro zone, Europe might bounce strongly and a solid play on the region might be a good idea. This is especially true if investors take a closer look at a few of the top ranked ETFs in the space for excellent exposure and some outperformance in the coming months.

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