Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Tom Becket, CIO of PSigma discusses the outlook for European equities.
Europe is once again generating nervous headlines in the press and concern amongst investors. Economic growth has ground to a halt in the 'big three' nations of Germany, France and Italy. Confidence in all three remains woeful. Yes, there are better trends from an admittedly low base in Spain, Portugal and Greece, where they have taken their dose of medicine, but a side-effect of the austerity pill is 'low-flation' and, in some cases, falling prices. Indeed, the timeliest European economic data suggests that the spectre of deflation could become a Europe-wide phenomenon, including in Scandinavia.
It is hard to become a structural bull of European equities
The rubbish economic data and worrying disinflationary trend has sparked increasingly desperate calls for the ECB to put their money where their mouth is and print euros. Indeed, most commentators now expect this to happen. Whilst we see this as a possibility, we are yet to be convinced that this is plausible, let alone probable. Ultimately ‘Super Mario’ Draghi will have to do something, but what he can and will be permitted to do remains highly debatable. He also does not seem keen on bailing out the woeful politics of certain European nations, such as France and Italy.
It seems more likely to us that instead of immediate QE a further cut in the deposit rate from -0.1% could be an acceptable step, thereby reducing the temptation for banks to keep money with the ECB. 'Lend, lend and lend some more' is Draghi's increasingly desperate plea to the banks; a request that has not been met with enthusiasm. The bulls would claim that the “targeted LTROs” coming later this year will spur fresh lending by the banks, but we don't know if €400 billion will be impetus enough.
There will also be some support from the ABS purchase programme that the ECB is working hard on, which should also benefit our investments in these markets, but again we would question whether this will suffice.
What is not up for debate is the fact that Europe needs help before it becomes Japanese. We have said for nearly five years now that the possibility of regionalised deflation in Euroland was a clear and present danger and with each passing day this claim looks increasingly prescient.
There's not enough growth and insufficient confidence, while the financial arteries remain clogged. This is not the recipe for success. The architects in chief of this misery remain the distinctly useless cohort of politicians leading Europe through this period of decay. Their refusal to reform their economies will see them fall further behind the US, Emerging Markets and, much to their disappointment, the UK. Last week the French politicians in their latest comedic act decided that they would simply scrap any attempt to get their deficit within previously agreed levels and Monsieur Sapin, the Finance Minister in the French 'Big Top', chose instead to blame the ECB for the lack of growth and insipid inflation.
So what does this mean for European assets? European credit can continue to perform well, despite the paltry yields, because there remains little chance of default and wide spreads over German bunds should keep the asset class in favour. Indeed, at the back end of last week the ten year German bund yield hit an amazing 0.97%, making corporate bonds very attractive. For European equities the outlook is far less clear; markets have recovered their poise over the last week, but with European equities having gained strongly in the last two years, without the justification of increasing profits, obvious value is hard to find. European profits now need the reality of improving profitability, rather than mere hope of a better tomorrow.
Where the Europeans once had selfless leaders they now have self-serving and timid masters such as Francois Hollande, who steadfastly refuse to make decisions for the greater good and help propel Europe away from its Japanese fate. While that remains the case it is hard to become a structural bull of European equities.
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