Jaisal Pastakia, Investment Manager at Heartwood Investment Management.
Concerns are building that the eurozone is heading towards stagnation, while the bearishness of European equity investors has been driven by the large underperformance of markets in the year-to-date. We believe that the negative sentiment is now somewhat overdone.
Although headline economic data has consistently disappointed in 2014, underlying details are showing signs of stabilising. Importantly, bank lending to non-financial corporates increased in September following several months of declines, while the rate of negative year-on-year growth has slowed. It is early days, but now that the European Central Bank’s (ECB) Asset Quality Review and stress tests are out of the way, we should see more appetite for lending in conjunction with an easing of credit standards, as evidenced in the ECB’s third quarter Bank Lending Survey.
Moreover, seasonal factors appear to have contributed to the summer slowdown in Germany, and those pressures look to be abating. A weaker euro should also provide relief to European exporters over the next few quarters, given the euro’s decline back to June 2012 levels versus the US dollar.
On the policy front, ECB quantitative easing is not guaranteed, but there is a higher probability that it will go ahead, given the Bank’s mandate is to maintain price stability. The ECB has done more than many could have imagined over the past few months, and we should expect the Bank to continue with growth supportive policies. Meanwhile, fiscal policy should be less of a drag on growth in 2015, as the European Commission forecasts a slight easing for the region in aggregate.
These are nascent indicators, but they provide hope that the eurozone economy is turning a corner, which should be supportive of asset prices in 2015. European equity is not a favoured trade and investors are generally underweight in Europe, which may provide a foundation for a share prices to recover. Full-year corporate earnings in 2014 are expected to be positive for the first time in four years. Furthermore, valuations in Europe remain attractive, especially relative to the US. Value trades by their nature are slower to come right!
That’s why we’re sticking with our overweight position in Europe, positioned to capture a potential recovery in earnings, valuations and liquidity.