Rebecca Jones asks three wealth managers whether they are adjusting allocations ahead of May's European parliamentary elections.
John Clarke, chief investment officer, GHC Capital Markets
We have been bullish on global equity markets since mid-2012, maintaining an overweight position. Within this, however, we remain wary of Europe.
Granted, the various ‘unconventional’ measures deployed by the ECB since November 2011– cuts in interest rates, unlimited cheap long-term loans to banks and the promise to purchase the bonds of distressed member states –have reduced the threat of the eurozone collapsing. However, this isn’t enough to make European equities a buy.
Investors are right to be concerned about the European elections in May and the potential for a fresh wave of volatility but, for us, the greatest worry is the outlook for the region’s economy.
Are you assessing your Europe exposure?
No doubt policymakers breathed a sigh of relief at the 0.3% expansion in Europe’s GDP in Q4 but we continue to question whether the upturn can be sustained. Central here are developments in the quantity of money. In the year to December, broad money (M3) increased by just 0.5%, while, excluding Germany, it actually declined by 0.1%.
What’s more, with the biggest single credit counterpart of broad money, bank lending, down 3.1% over the same period, the chances are monetary growth will weaken further.
The only way of preventing this would be for the ECB to start purchasing longer dated government bonds from the non-bank private sector, thereby countering the effect of falling bank lending on the quantity of money.
But with the governing council fearing (wrongly) that such action is inherently inflationary, we cannot see this happening. Since, in our model, money is the key determinant of nominal national income, the result will be a sustained period of weak economic growth allied with the growing threat of deflation. We will remain underweight.
David Cowell, director, Myddleton Croft
There is no doubt peripheral Europe is collectively in a tricky situation. Some of the EU members not in the eurozone, in common with emerging markets, are finding it extremely difficult following the Fed’s decision to begin tapering QE.
But European economic growth does look to be improving and it will need to as the tailwind from growth in emerging markets is moderating at the same time.
Increasingly, this will manifest itself in sector leadership, which we consider rotated last year from defensive/emerging market-facing companies to a more domestic and cyclical focus.
It now looks as though Germany’s Bundesbank is going to toe the EU line on ‘sanitising’ ECB lending, ensuring it is likely to studiously ignore the protests in both parliament and the constitutional court that such lending is unlawful. This could pave the way for greater bank liquidity and a further easing of interbank rates, and head off the threat of deflation.
Looking at valuations, based on cyclically adjusted price/earnings ratios, Europe is more than 30% cheaper than the US, with greater recovery potential, given profit margins are at an earlier stage of recovery than in the States. This is a positive medium-term trend and explains our relative overweight in Europe and underweight in the US.
Tail risks have ebbed as Western growth has improved and, as a consequence, we expect less correlation between markets, sectors and stocks. This should, therefore, be an excellent time to be focused on stock-pickers.
We are not invested in economies, rather underlying companies. We don’t expect markets will take off but we see there may be a more considerable performance divergence between stocks, sectors and countries.
Tim Gregory, head of global equities, Psigma
Previously, when markets have worried about Europe, it has been when the solidarity of the euro has been called into question. That was the headline every day up until July 2012, when Draghi promised to do “whatever it takes” to support the currency but, since then, monetary policy has been very easy.
We’ve generally looked at Italian and Spanish bonds as a benchmark for risk appetite and, earlier last week, they were at eight-year lows, yielding only 3.6% – not even 100bps higher than UK and US government bonds yielding 2.7%.
If anything, there is significant complacency priced into the outlook for European bonds, which is telling you the market is not as concerned about the stability of Europe as it was 18 months ago. What we have seen recently is a flood of money into European equities, particularly as emerging markets have fallen out of favour and PMI data has suggested Europe’s economy is improving.
There is political risk posed by the upcoming European parliamentary elections. These are always things you’ve got to keep in mind and, really, you cannot separate politics from the investment debate.
A lot of the problems in Europe during recent years have been politically inspired and markets are currently complacent. It’s not beyond the bounds of possibility that, when the European parliament reshapes in May, it could be dominated by euro-skeptics.
However, I do not think that’s priced into anybody’s expectations at the moment. People are very optimistic about European equities and bond markets are certainly not predicting any kind of dislocation.
Investors would be completely correct to be keeping an eye on that situation but completely shifting a portfolio based on political events that may or may not occur is risky.
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