There is political uncertainty but investor fretting is overdoneby Duncan Weldon / May 9, 2019 / Leave a comment
Investors have become used to fretting about Europe. That is particularly true in the context of Brexit-related uncertainty, but concerns go back much further. The politics always seem a mess, a crisis usually appears imminent and growth is often soggy. Structural flaws in the design of the euro—a single currency not backed by a single fiscal authority or fully unified capital market—appear to leave open the risk of a dangerous accident. So what is the outlook for the months ahead?
Over the last decade an investor in continental European stocks, assuming dividends were reinvested, would have made around 9 per cent per annum. While that is a decent return by historical standards, the same cash invested in American equities would have returned over 16 per cent per year, or 11 per cent if invested in UK equities.
Having underperformed their US peers for a decade, European stocks look relatively cheap. Valuations are certainly less stretched than across the Atlantic but the worry is that sometimes things are cheap for a reason. Profit margins are higher in the US and prospects for earnings per share growth look rosier.
Much of the difference can be explained by the contrasting macroeconomic performance. The US recovery started earlier and proceeded more smoothly than in Europe. A more aggressive monetary and fiscal response from 2009-2012 kick-started a bounceback that has since been juiced by Trump’s tax cuts. By contrast, quantitative easing in the eurozone only kicked in six years later. Thus today, while American unemployment is now at historic lows, eurozone joblessness is still above pre-crash levels. And a recent slowdown in European growth has prompted new worries. The eurozone finally notched up half-respectable growth of 2 per cent plus annually between 2015 and 2017, but progress slowed sharply in late 2018. With the first quarter of 2019 not looking too clever either, investors are nervously pondering their European allocations.
Myriad factors can be blamed: changing emissions standards hitting the car industry, China’s slowing growth, the gilets jaunes protests discouraging spending in France, uncertainty reflecting the great Rome-Brussels stand-off over budget deficits. Or, of course, Brexit. But when a different set of “special circumstances” is paraded around each quarter to explain weakness, patience wares. Add in persistently low inflation and an ageing and shrinking European workforce, and some conclude that Europe faces a “Japanification” and a future of weak growth. Viewed through that lens, the current slowdown is not cyclical, but structural.
These concerns are justified. But that is not a reason to sell relatively cheap European assets right now. Monetary policy remains supportive of growth, and fiscal policy is loosening. Growth may have slowed, but recession doesn’t look imminent. Eurozone politics may be fraught, but the odds remain against any country quitting the currency or defaulting any time soon. A transatlantic trade war, with tariffs on European cars, is a potentially a risk. But that would spell trouble in America too, and having moved to settle his fight with China, Trump surely wants to bank smoother growth ahead of his re-election campaign.
With all this in mind, it’s easy to overdo the worries about European assets, especially when prices are already modest.
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