Is Now the Time for European Equities?January 29, 2015
The European Central Bank (ECB) has at last decided to utilize its final weapon, massive and open-ended balance sheet expansion through the purchasing of sovereign and agency debt, to fight deflation and stimulate the European economies. This quantitative easing (QE) is a so-called “unconventional” monetary policy tool but one already used by the United States, Japan and the United Kingdom. The experience to date with this approach suggests that in the Eurozone there will be further downward pressure on the euro’s exchange rate; the risk of deflation will be lessened; and interest rates, which are already close to zero, will remain very low for the foreseeable future. Pumping more liquidity into the economy will have only a limited effect in expanding credit unless the demand for credit grows. There are some early indications that credit demand is picking up. In sum, the direct effect of QE on the rate of economic growth may be modest, coming mainly through the lower exchange rate’s effect on exports and a general improvement in business and consumer attitudes.
An important further effect of QE, which my colleague David Kotok explained in a recent commentary, is a rise in asset prices, especially equity prices. QE withdraws duration from the market. Asset prices rise when duration is in demand. As equities are a long-duration asset, this is one positive factor in the outlook for Eurozone equity markets in 2015. It is one of the several reasons we are bullish on Eurozone equities this year.
Another reason is the improving macroeconomic situation of a number of the main Eurozone economies. The latest (January 23) Markit Flash Eurozone PMI (Purchasing Managers’ Index) Composite Output Index is 52.2, which is a five-month high. The Flash Eurozone Manufacturing PMI Output Index is also 52.2, a six-month high. France and Italy, however, are moving in the opposite direction, with contracting PMIs. The oil price decline has led to a drop in input costs in the Eurozone and is feeding through to product prices, a plus for households, which are stepping up their spending. New orders in the Eurozone are advancing at the highest rate in five months.
We expect that the Eurozone’s GDP growth this year could be 1.5 percent, some 66 percent faster than the 2014 rate. That will still be only half the US economy’s projected 3 percent pace, but the acceleration in Europe from a situation of substantial slack to one of above-long-term trend growth will be very positive for profit margins.
In sum, we believe 2015 is likely to be a good year for the Eurozone equity markets as a group, with Italy and France underperforming; Spain, Belgium and Netherlands outperforming; and Germany at the average for the zone.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.
The preceding is an abridged commentary by Cumberland Advisors and has been reposted with permission. Cumberland Advisors commentaries are available at http://www.cumber.com/commentary_archive.aspx.
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