22nd April 2013
It is tempting – and commonplace – to think of Europe as an unmitigated economic and investment disaster. Yet while there can be little doubt that parts of the Eurozone appear mired in recessions so deep that they could take a generation to emerge, do investors risk being blinkered about some of Europe’s brighter spots? Investment journalist Cherry Reynard reports.
The overall picture in Europe is still gloomy. Ian Stewart, Deloitte’s chief economist in the UK, points out that all of ten of the world’s weakest economies in 2013 are in Europe. He says: “The Greek, Portuguese, Spanish and Italian economies are forecast to contract sharply this year and these countries are at the bottom of the global growth league. Economists slashed their forecasts for European growth through last year and have continued to cut them since the start of 2013, suggesting continued gloom about growth prospects this year. The euro area is expected to contract again in 2013 at about the same rate as it did in 2012, by 0.4%.”
Equally, the Eurozone’s second largest economy – France – is starting to look more ‘periphery’ than core, thanks to the economic mismanagement of Francois Hollande, according to Tom Becket, chief investment officer at Psigma: “In the last few weeks we have seen every data point confirming what we had feared; France is sinking further in to the economic mire. Unemployment is rising, all parts of the economy contracting and business confidence collapsing. In short, ce n’est pas bien. The worst thing is that any recovery seems truly elusive and businesses and consumers either don’t want to or can’t spend. Outside of Paris there has been a massive slump in property prices.” The Spanish and Italian economies are still struggling to regain momentum.
But this weakness is well-known and acknowledged by markets. What is less widely recognised are the pockets of improvement in certain parts of the Eurozone economy. For example, Eurozone industrial output edged higher in February thanks to a jump in energy production as FT.com reports. The rise of 0.4 per cent in February over January was ahead of economists’ forecasts and reversed a 0.6 per cent fall in January. Admittedly, it is still 3.1 per cent lower than a year ago, but it does suggest an improving trend.
While many of the peripheral countries remain weak, there are signs that a select few are turning themselves around. Stewart points out that Iceland, Latvia and Ireland have all rebounded from their deep recessions and are growing again. Equally Ted Scott, director global strategy, F&C, highlights the strides that the Portuguese government has made in improving the economy, despite the ongoing recession: “Like Spain, the external account of Portugal has also shown a dramatic improvement. The current account deficit has fallen from 10.4% to just 0.3% of GDP. This is partly due to a sharp fall in imports that reflects the current weakness of the domestic economy, but is also due to a creditable rise in exports.”
Patrick Moonen, senior equity strategist at ING Investment Management argues that a weaker Euro and global recovery will boost exports, particularly in countries such as Germany. Additionally, he says, fiscal tightening should be less of a headwind in 2013.
Also, the economic picture does not have to get a lot better for the current market valuations to look pessimistic. European stock market valuations are still undemanding relative to the rest of the world. The S&P is up 16.8% over five years (source: FT to 5th April), compared to a fall of 9.93% for the FTSE Eurofirst index.
Mark Pignatelli, manager of the Smith & Williamson European Growth Trust is clear that the picture is changing for the better in Europe: “Then we get to the Euro crisis itself – the game looks to be changing for the good… obvious why…OMTs, the ESM, the ECB’s balance sheet has shrunk during the past nine months etc. It’s worked and the market is screaming that at us particularly since its bullish resolve has been successfully tested recently by Cyprus and Beppe Grillo in Italy. Amazingly some economic research houses are pointing in exactly the wrong direction as they think the whole region will blow up. We should stop concerning ourselves with the Euro crisis and start focussing instead on what will happen to the profit cycle over the next 18 months.” The profit cycle, he believes, is about to hit a sweet spot.
Of course, the delicate political and economic situation in Eurozone and other parts of Europe still argues for caution. For example, Cedric de Fonclaire, manager of the Jupiter European Special Situations fund, believes that banks are too vulnerable to political intervention and therefore best avoided. He sees similar problems for the utilities sector. Equally, he believes that any capital intensive industries, such as oil, will also suffer in this environment, in spite of their relatively low valuations. He says earnings momentum more than low valuation is likely to drive share price growth.
The European economic situation may be dire, but that should not blind investors to areas of improvement. Markets are well-aware of the weak spots, but have shrugged off the recent crises in Cyprus and Italy. As the economy of key trading partner the US, Europe may have more capacity to surprise positively, given that few investors expect anything at all.