Invesco’s Mustoe sees reasons for optimism on European equities
Invesco Perpetual’s CIO Nick Mustoe, writes financial markets continue to be driven by both central bank policy and currency moves.
After the European Central Bank (ECB) announced an asset-purchase programme to the tune of €60bn (£45bn) a month to buy government debt, it caused ripple effects among European currencies. Even before the ECB’s policy meeting, there had already been repercussions. The Swiss National Bank (SNB) unexpectedly abandoned its long-standing cap against the euro, sending the Swiss franc soaring against the single currency. The move has implications for Switzerland’s exporters, and it triggered a corresponding plunge in the Swiss stock market.
Indeed, the ECB’s much anticipated decision to launch outright quantitative easing (QE), aimed at reviving growth and protecting the Eurozone from deflation, is likely to impact countries elsewhere in Europe too. Of course, the launch of QE, in conjunction with weak oil prices, could trigger another round of monetary easing across the world, eventually lifting inflation expectations and leading to stronger global growth.
In terms of the weak oil price, to a large extent this has been interpreted as negative news: as a reflection of the weak state of the global economy, a driver for deflation in the Eurozone, and significant trouble for oil producers, implying lower energy-related investments and financial distress. This contrasts with conventional economic wisdom (thus far largely ignored) that a lower oil price is a net positive for global growth, as the benefits from higher real incomes, lower input costs, and improved current accounts for the larger group of oil importers outweigh the losses for oil exporters. In my view, the market reaction has been extreme for such a small supply demand imbalance in the context of the past 30 years or so. It’s hard not to believe that the oil price won’t be higher again in a few months.
Notwithstanding the potential positive impact of lower oil prices in the future, the significant size and the open-ended nature of the ECB’s new programme were positively received by financial markets. The announcement of QE has been hugely supportive for financial markets, more so than for the real economy. It should provide a real boost for European equities and underlines our bullish views on the asset class. The market reaction was instant. The euro dropped to an 11-year low. Bond yields fell as the prices of those bonds in Italy, Spain and Portugal rose.
As the focus shifted to the Greek elections last weekend, it turned out to be more of a side-show than had previously been expected. While fears of a Greek exit from the Eurozone sent stock markets tumbling in 2012, the reaction to the Greek rejection of austerity has so far been much more muted. Spanish and Portuguese bond yields were little moved.
Meanwhile, the flattening of the yield curve now means that there’s little difference between short-term and long-term government bonds. In the UK, 30-year gilts have just hit an all-time low and are currently offering a yield of just over 2%, which represents poor value in my view.
I feel increasingly positive on European equities based on the market’s reluctance to believe that there’s upside to growth and earnings for European companies. As a result, European equities are still valued at a large discount on both a relative and historic basis. The ECB action cements their attractiveness in my view.