Calling time on the European recovery is a mistake
John Bilton, global head of Multi Asset Solutions and Thushka Maharaj, Global Strategist, Multi Asset Solutions, JP Morgan Asset Management
Is another global recession right around the corner? That growing fear amongst investors is manifest in European assets, where global tensions have put a spotlight on European banks. But despite the faint echoes of the 2011-12 crisis, this is no re-run of history. The reality is at the same time more mundane and more complex.
Recession risks may have risen, but we still envision a year of tepid but positive global growth.
For an asset allocator, Europe might well be thought of as a perfect test tube for the experimental – and potentially volatile – mix of economic recovery, inventive monetary policy, and untested financial regulation. From an investor’s perspective, Europe offers tantalising dividend yield and pro-cyclical policy stimulus tempered by the scars of the more recent eurozone banking and sovereign crisis.
How should investors think about Europe now? In our view, the trinity of global growth, the local banking sector and central bank policy will be especially important for European assets in 2016.
The outlook for European growth is on a reasonably solid footing; nevertheless, Europe is a mature and relatively low growth region. The domestic picture continues to improve, with an uptick in consumer credit demand and improving confidence acting as an anchor for growth.
Yet Europe is more internationally exposed than the US – rendering the emerging markets slowdown and the subsequent slump in world trade as significant drags. The net result is slow but steady domestic growth tempered with a lingering concern that Europe could import emerging market economic malaise and snuff out the nascent recovery.
The poor performance of Italian equities thus far in 2016 highlights the second key consideration for European assets – the banking sector. Banks account for 25.6% of the market weight of the Italian FTSEMIB index, compared with 13.8% of the Eurostoxx-50, 8.8% of the French CAC-40, and just 1% of the German DAX.
Renewed concerns about Italian non-performing loans (NPLs) snowballed into broader concerns about banking sector liquidity, solvency and earnings.
In our view, the liquidity and solvency of the European banking sector are no longer systemic issues. Liquidity metrics are at barely a tenth of the level they hit during the GFC and a sixth of the peak from the Eurozone crisis. Lower reliance on wholesale funding, plus European Central Bank (ECB) liquidity backstops, limit the risk of a liquidity crisis today.
Solvency fears are also exaggerated. Core Equity Tier-1 (CET1) ratios – a key metric for bank solvency – are a creditable 12.8%, vs a pre-crisis low of around 7%, and loan-to-deposit ratios are at around 100%, down from 112% pre financial crisis.