Cyprus Plans Shake Up Europe ETFs

News that the little Mediterranean island of Cyprus is looking to impose a tax on bank deposits to fund some of its needed financial-system bailout sent a wave of outsized ripples across financial markets Monday, pushing many Europe-focused ETFs lower on worries the effects of the tax could spread far beyond Cyprus.

Cyprus’ decision to vote on a tax—as high as 9.9 percent—to be levied against bank depositors in an attempt to raise $7.6 billion to help bail out its financial system, as reported by the Wall Street Journal, raised concerns that not only local citizens would be rushing to ATMs to withdraw their savings, but that the fear could cause contagion across Europe and even in the United States.

"For Cyprus, where the financial and insurance sector accounts for around 8 percent of gross domestic product, the proposed measures will probably lead to a substantial loss in the financial sector and therefore weaken the overall economy," a research note from Stratfor, the geopolitical consultancy, said Monday.

Going forward, much depends on how German opposition to using taxpayer dollars for bailouts plans shakes out, and an upcoming German parliamentary election all but ensures the question will get an extended hearing that could have implications well beyond the borders of the eurozone’s largest economy.

"Finding a balance between addressing the Euroskeptic voters in northern Europe while ensuring cohesion of the eurozone is becoming more difficult, especially for Germany, which is facing rising opposition in Europe," the note from the Austin, Texas-based think tank said.

"Depositors in other troubled countries, such as Spain or Portugal, will be increasingly concerned that future rescue measures would result in similar taxes on their deposits," Stratfor added. "Therefore, any future signs of financial instability in certain countries will likely lead to capital flight and aggravate the crisis further."

The $1.7 billion SPDR Euro Stoxx 50 ETF (FEZ)—a fund that taps into some of the largest companies across Europe and holds France and Germany as its two largest country allocations—dropped 2.12 percent Monday, erasing many of the gains tallied in the past 10 days. The losses came as the Dow Jones industrial average slipped 0.43 percent on the day while the S'P 500 dropped 0.55 percent.

Similar weakness was also seen in the behemoth $41.4 billion iShares MSCI EAFE Index Fund (EFA), which ended the day 1.1 percent lower after gapping to the downside in daily charts. The developed-world-focused portfolio of some 900 securities has more than half its country exposure tied to European nations, but the fund remains ahead by more than 4 percent year-to-date.

For now, banks in Cyprus remain closed at least until later this week, and a vote on the proposed tax has been postponed as regulators grapple with the implications of making this move. For U.S. investors, the latest tidbit out of Europe is a blunt reminder of the fragility of the so-called global economic recovery, with another round of eurozone-centered issues clouding the outlook for U.S. growth.

Other ETFs worth noting include the $16.7 billion Vanguard FTSE All-World ex-US ETF (VEU), which also slipped 1.1 percent Monday. The fund taps into developed and emerging economies with the exception of the U.S., and roughly 45 percent of the 2,332-stock portfolio is currently allocated to Europe.

The CurrencyShares Euro Trust (FXE), sponsored by Guggenheim Investments, is a currency play on the euro. The fund closed 1 percent lower Monday.

FXE hit a peak of $135.49 a share on Feb. 1, but has since been declining steadily, having now slipped some 5 percent from that level.

Even as these funds underperform, investors have still poured assets into ETFs that serve up exposure to Europe.

Year-to-date, all of these eurozone-focused portfolios have been net gatherers of assets, with EFA leading the pack with net inflows of $744 million since Jan. 1.

VEU has attracted a net of $640 million, while FEZ and FXE have seen inflows of $541 million and $36 million, respectively, according to data compiled by IndexUniverse.


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