Europe's Camouflaged Recovery // C.J. Lawrence Blog
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Seeing is Believing – Europe ’s Camouflaged Recovery

Turbulence has marked the 3rd quarter of 2015 for global markets.  Recent moves have been acutely painful but they are unremarkable in the context of long-term history.  However, investors’ short-term memories have been jolted; yes markets do go down as well as up and more often than not with greater violence.  No corner in the world has been spared the volatility, Europe especially.  The regional economy and markets are still closer to departure than destination on the road to recovery but unlike 4 years ago, during almost the same period of 2011, the region has held its ground rather than packing up and going home.  Sure it is heavy weather but European economic data weighs more positively than negatively and is crucially aligned with our base thesis of a continued slow march of recovery with significant headroom to expectations.

Headline risk is overpowering grass roots analysis in Europe.  Persistent negative headlines: Greece, migrant crisis, now Volkswagen (no we don’t hold this in the Euro Select) etc…have a stranglehold on investor sentiment for the region but closer inspection reveals a groundswell of better fundamentals supported by more optimism in sentiment indicators.  UK GDP growth continues to lead developed economies with 2.6% growth forecast for 2015.  Euro area growth is expected to average 1.5% heading towards 2.0% for 2016.  That puts the combined group almost on a par with near term U.S. growth.  When we launch the European Select UIT in early 2014, the region was barely breaking into positive territory.  Bloomberg data points to a 6.7% increase in earnings for Europe in 2015 compared with U.S. profits that are expected to barely breakeven with 2014.   Significant and prolonged under performance from European companies versus the U.S. leaves the region with plenty of room to run in the coming years.

Sentiment indicators in Europe have been robust despite the market turmoil.  Employment conditions across the region are improving, albeit slowly, and increased consumer spending is echoing the creeping improvements.   Three major tailwinds remain in place for European equities: low energy prices, a weaker Euro and ultra-accommodative central bank policy.  Oil prices have pushed inflation marginally negative, increasing pressure on the ECB to expand its QE program.  Estimates suggest that Draghi may push bond purchases beyond 2016 and expand the Central bank’s balance sheet by over Euro 2 trillion, an enormous injection of capital by any other standards. 

Of note also is the push across Europe for greater banking union.  The major market difference between Europe and the U.S. ─ and the main driver of Europe’s sustained economic underperformance─ is the region’s almost complete reliance on bank lending for business financing.  In the U.S. almost 80% of corporate financing is fulfilled through capital markets and only 20% through bank lending.  The implication are that post financial crisis where bank balance sheets are impaired corporate finance in Europe has been suffocated.  The EU is fully engaged with the problem and the creation of a true European capital market would provide a significant boost to the economy. 

European market performance is also showing signs of relative strength in an otherwise down market.  The STOXX 600 has round tripped from a positive 1st quarter return of 15% then pulled down during the (Greek crisis) second quarter and the global correction of the 3rd quarter to end September down just over 4% in USD terms.  That is compared to an S&P 500 down a little over 5% during the same period.  A fairly hollow claim but that’s the first signs of sustained outperformance by Europe in a very long-time and should encourage more investors to hang in there for better times ahead.


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