By Jeff Taylor, a fund manager at Invesco Perpetual Modest levels of economic growth in the euro...
By Jeff Taylor, a fund manager at Invesco Perpetual
Modest levels of economic growth in the eurozone have been eroded further since the spring and leading economic indicators in many countries have deteriorated.
Worst affected has been Germany, which accounts for about 30% of the eurozone economy. Here, business surveys have been slipping, consumer spending has deteriorated and unemployment has risen.
The countries that make up the remaining 70% of the eurozone have been less badly afflicted. In France and Italy, for instance, consumer spending has been growing in recent months.
Moreover, for much of Europe, personal savings ratios are much higher than in the US or the UK while household debt levels are much lower. This means that, for the eurozone as a whole, the risk of consumer retrenchment is relatively low.
In Spain, government infrastructure projects have been helping to keep the economy strong.
The Spanish government has said that it will increase infrastructure spending by 8% next year from already buoyant levels.
The European Central Bank's (ECB) dogged determination to see eurozone inflation drop below its 2.0% target rate has been instrumental in preventing it from easing monetary policy this year.
Calls from EU ministers for an easing of the stringent economic conditions imposed by the region's stability pact have not helped.
Last month, the ECB described the stability pact as a necessary adjunct to its setting of monetary policy. Despite this, however, it seems likely that the ECB will find it increasingly difficult to resist calls for lower interest rates.
Unsurprisingly, Europe's stock markets have performed poorly in an environment of slowing economic growth and stable interest rates. Earnings expectations, which had stabilised around the beginning of the year, deteriorated sharply through the summer.
The result was that equities were de-rated quite savagely during the third quarter of the year, as share prices fell even faster than earnings expectations. By the end of September, European equity valuations had begun to look depressed.
Dividend yields, at around 3.4%, exceeded short-term interest rates while price-to-earnings multiples, on a rolling 12-month basis, had dropped to just 12.5 times.
In response to low share valuations and an apparent stabilisation in forward earnings estimates, we increased our positions in the financials sector at the beginning of October, particularly insurers, which had suffered near-panic selling during the final weeks of September.
Since then, European stock markets have rallied very sharply.
In the longer term, we believe that the eurozone economy is heading for several years of sluggish growth and we have organised our equity portfolios to take account of this.
We retain exposure to some defensive sectors, including holdings in pharmaceuticals and an overweight position in utilities.
Equities undervalued at present.
Earnings forecasts are stabilising.
Consumer balance sheets healthy.
German economy is faltering.
Leading indicators remain weak.
ECB is excessively hawkish.
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