In recent years the European economy has been dragged from its slumber by strong global growth and n...
In recent years the European economy has been dragged from its slumber by strong global growth and not by domestic demand. While the entire stockmarket has done well, equity investors have been extremely well rewarded for taking a "pro-cyclical" or "pro-global growth" stance. Industrials, in particular, have been spectacular performers. This performance has followed as more and more market participants started to recognise the buying power of the developing economies, a view that is now well established.
So what is the outlook on growth? We are in a peculiar situation where the developed economies are slowing while the emerging markets continue to surge. Developed economies make up around 70% of global GDP and the emerging economies around 30%. While there is a certain amount of decoupling going on between the two areas, it is still quite limited. Trade flows necessitate that with the G7 slowdown, the emerging economies ought to slow, at least somewhat.
Where does that leave Europe? Clearly, the huge external stimulus from global growth is ebbing. While the change is not too severe, the effect will be felt in some of the hottest industries of recent years. Given this slowdown, for the European economy to maintain its growth trajectory, we need an upturn in domestic demand. That is, we need the consumer to spend more. In the short term, this second wind from consumption looks less likely to come through. The credit crisis has led to tighter lending criteria and a more cautious consumer.
The longer term situation looks better. With the exception of Ireland and Spain, most European countries are underleveraged. Household debt as a percentage of GDP is low and has plenty of room to rise. With decent employment figures, consumer confidence can rise and the savings rate can fall.
So the short-term picture from a growth perspective is mixed, but there is good news; most importantly, valuations are not stretched. The free cashflow yield of European equities is still above the bond yield. The market is also pleasingly diverse, so there are always opportunities, regardless of market conditions.
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