Investment Strategy:  Third Quarter – Specific Market Reviews: Europe

  • The year started with fears that the Eurozone was plunging into recession but this proved to be overly pessimistic. The Eurozone economy bounced back in the first quarter. Growth across the bloc accelerated to 1.5% y/y from 0.9% y/y in the final three months of 2018. The region was buoyed by strong expansion in Spain, which enjoyed quarter-on-quarter growth of 0.7%, while Italy grew 0.2%, emerging from recession. There was particular relief in Germany where the great old locomotive had itself been teetering on recession with gloom in the famous ‘Mittelstand’ small and medium size specialist companies that supply much of the machinery for factories around the world. 
  • The positive economic numbers cheered markets but major concerns remain, reflecting ongoing subdued survey readings, particularly on manufacturing. With around 45% of GDP coming from exports the Eurozone is particularly sensitive to a slowdown in global trade and so would be a big loser from any escalation in the trade wars. If we’re not too careful we’ll be back to talking about the ‘Japanification’ of Europe, many years of deflation and minimal growth in other words.
  • Slower growth is certainly on the mind of Mario Draghi in his last few months of his lauded reign as head honcho at the ECB and he is back in ‘whatever it takes’ mode talking of ‘considerable headroom’ for more asset purchases (QE) or interest rate cuts. This has implications for the stock market of course, not least for the financial stocks that account for roughly 20% of European indices. Should the ECB be forced to cut rates into even deeper territory the outlook for these stocks gets ever worse. 
  • The results from the European Parliament voting across the continent changes the narrative of Brussels politics, weakening the grand centrist coalition and signalling the rise of anti-establishment parties, be they left or right,  populist, nationalist, radicals or Greens. This has given rise to a fractured and potentially chaotic EU Parliament and the dysfunctionality of Eurozone politics grows ever apace. 
  • As with other global markets and despite the deteriorating fundamentals, European markets continue to ratchet up strong gains with most bourses producing a double digit return for the year. The MSCI Europe is now trading on a forward P/E of around 13.5x which feels pretty much like fair value.

Summary: Equity markets have produced strong returns this year but fundamentals remain challenging as growth and earnings estimates falter and politics remain as dysfunctional as ever.

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