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BLOG: Europe’s Fellowship journey through darkest hour

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Written by: Fabrizio Quirighetti
11/05/2017
Emmanuel Macron's recent French presidential election victory shows there is light at the end of the tunnel for European equities.

The Great Recession of 2007/08 and the ensuing debt crisis of 2011/12 pushed the euro area into a Mordor-like world; a “futureless” economic zone, locked in a weak growth environment, plagued by high unemployment and mounting bad loans. To make matters worse, a failure to make necessary reforms exacerbated the region’s listlessness.

The amassing dark clouds have been so persistent that populism and a furious political backlash reached a point where the probability of disintegration became very likely. It was especially frightening as this danger was coming from France, one of the founding members of the European project, which reconciles both peripheral and core characteristics.

In other words, the dark night was nigh despite Mario Draghi (president of the ECB) doing a reprise of Gandalf’s “You shall not pass” scene and telling the market the European Central Bank would do whatever it took to avoid the worst.

Fortunately, like a good Hollywood movie, there has been a sudden and almost unbelievable twist which ushered in a new wind of hope and freshness: according to the outcome of the French presidential elections, taking the unknown Frodo-esque role, Emmanuel Macron has become the next President of the Fifth Republic.

Investors see the light

Suddenly there is light at the end of the tunnel. And with bluer skies on the horizon, investors are realising the economic outlook of the euro area isn’t as dark as previously perceived. Indeed, real GDP growth is currently running at around 2% – a level not seen since the short-term recovery of 2010 – which is comparable, if not better, than the performance of the US market and is clearly higher than the estimated 1% potential.

Meanwhile, we should see the release of pent-up demand due to a number of tailwinds. Firstly, unemployment rates should continue to fall from extremely high levels. Secondly, the situation regarding bad loans should improve with a rising nominal growth tide. Finally, a welcome dose of hope and reforms may jump-start moribund investments by both domestic and foreign companies.

Macron – Europe’s saviour?

In summary, the European recovery is quite new (and somewhat unexpected) compared with the eight consecutive years of expansion for the US economy. Trumponomics and reflation hopes are already starting to fade away, while Macron may now be seen as the saviour who resuscitates the euro and restores French splendour.

As a result, we believe it’s now time to reload some risk in the portfolios and more specifically in European equities, which benefit from relatively interesting valuations and should thus attract significant foreign flows which had deserted markets in the last few years. Our duration stance has been downgraded slightly as there is now upward risk to German rates if investors start to price in a European tapering.

We are still in a global scenario similar to Japan’s lost decades, at least until any meaningfully socio-economic-political reforms have been implemented. European equities are now moving higher in our allocation range, and the US is moving down. If we are right, US Treasuries are likely to be the “least worst” place to be in the govies space, and the strong US dollar era is certainly behind us.

Fabrizio Quirighetti is chief investment officer and co-head of multi-asset at SYZ Asset Management

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