Threadneedle’s Dicken on how to navigate European equities in a slow-growth world
Philip Dicken, head of European equities at Threadneedle Investments, outlines his path in selecting assets at a time of slow growth.
Q: The European macroeconomic background remains difficult. How long do you expect this situation to continue?
If we look at the leading indicators, they suggest that conditions are continuing to deteriorate. For example, the eurozone manufacturing purchasing managers’ index is well below 50 and falling. Of course, there are winners and losers within this, with core manufacturing and exporting nations such as Germany recording much better rates of growth while peripheral countries such as Greece and Spain are deep in recession. Overall, though, we expect the eurozone economy to contract by 1% this year.
What is more, the effects of deleveraging, which have constrained growth over the past few years in the UK and US, are only now starting to be felt in Europe. Bank balance sheets have not yet been reduced significantly in Europe and, as this process begins in earnest, the eurozone economy will come under further downward pressure. So the growth differential between the US, which is now in modest recovery mode, and Europe is probably going to get wider over the next couple of years.
Q: Does the result of the second Greek election make you more confident that Greece will stay in the euro?
Not really. It has reduced the risk of a disorderly exit in the short term, but the longer-term outlook remains difficult. We will have to see what happens with the new coalition but we anticipate more negotiations as the Greeks try to obtain easier terms on their bail-out packages. Naturally, the bodies that have lent them the money – particularly Germany – wish to keep the terms as they are.
Ultimately, we think that Greece will leave the euro and that this unpleasant experience will be countered by significant liquidity injections from central banks. One plus point is that the pain that Greece will endure outside the eurozone should serve to galvanise the other peripheral nations, limiting the risk of a domino effect developing.
Q: What has the eurozone learnt from the Greek experience?
Greece has shown that, for highly indebted nations, austerity alone is not enough. Cutbacks have been made in Greece and yet, because GDP is shrinking more quickly than spending, debt to GDP has continued to rise. The realisation that austerity alone doesn’t work has dawned across much of Europe over the past few months, and is one reason why François Hollande was elected as president in France. He fought the election on a growth platform and his arrival has changed the landscape somewhat, with Germany starting to look more isolated in promoting an austerity-first approach.
The problem is that Germany has been through its own austerity era, following re-unification in the early 1990s. Later, from 2003, Gerhard Schröder reduced state benefits and liberalised labour markets, transforming the country from one of the weakest economies in the region to the industrial powerhouse of the eurozone. So it has proved that austerity is tough, but that it works. Having been through that hardship itself, it is no surprise that Germany is not keen to cut Greece and the others too much slack.
Q: How does this uncertainty feed through to equity markets?
First of all it feeds through to very poor sentiment towards all risk assets, but towards European equities in particular. In some senses this is understandable, as European companies are, in many cases, more exposed to the stresses in the eurozone than their international counterparts. However, this is not always the case and we would argue that European stock markets are oversold relative to corporate fundamentals. The ratio of earnings upgrades to downgrades is positive in Europe and the market is now trading cheaply. If investors can take a deep breath and look beyond the macroeconomic and political news flow, today’s valuations could be seen as an excellent long-term buying opportunity.