BLOG: Is quantitative easing boosting European markets?
We believe that even if the ECB increases its QE programme, it is unlikely to be enough. Structural reforms at an individual country level are essential for job creation and progress is slow. In the short term, QE could help prop up the region’s markets, but they still need a solid economic recovery to justify higher asset prices over the long term.
Although conditions have improved since the financial crisis, Europe still suffers from low economic growth, high unemployment and deflationary pressures. This uncertainty risks important spending and investment plans. A weak labour market means wages are also unlikely to rise. In recent weeks, German bunds have been more volatile following some economic surprises in Europe, and higher oil and commodity prices. We believe this attention to ‘inflationary’ pressures will be short-lived.
When faced with recession and the threat of deflation back in 2009, central banks in the UK and US acted swiftly by launching QE. Following a long wait, the ECB has finally acted, but we remain sceptical that it will do much more than weaken the euro. The ECB plans to buy €60 billion of assets every month until September 2016, which would amount to €1.1 trillion – small when compared to purchase amounts by the UK and currently by the Bank of Japan. In the first instance, we doubt QE will encourage the eurozone’s banks to increase the amount they are lending to the region’s businesses.
The US and UK suffered the same problems, when commercial banks used the additional liquidity to increase their cash balances. Europe’s banks are unlikely to enjoy much demand for credit from the region’s indebted consumers or businesses. Second, bank business models remain broken and long-term refinancing operations to eurozone banks by the ECB have largely failed.
Some evidence suggests QE boosted consumption in the US and UK through the ‘wealth effect’. This is when rising stock markets in the US and increasing house prices in the UK made people feel a bit wealthier and it encourages them to spend. Yet far fewer continental Europeans own shares or their own homes, so the mechanism is unlikely to have the same impact.
The greatest threat to the eurozone has been the fate of the euro itself. Year-to-date, the currency has plunged 12.6 per cent, reaching near-parity with the US dollar for the first time since 2000 – arguably good news for exporters. But investors must be mindful of companies that have dollar-denominated supply chains as well as those that sell their products in emerging markets, which are suffering a slowdown.
Furthermore, Greece’s fate looms large. While we don’t believe a ‘Grexit’ exit is the systemic event it once was, but it does have the potential to shake confidence. Until Europe finds a palatable solution to Greece’s attempts to renegotiate the terms of its bailout, financial markets will remain vulnerable to the uncertainty, especially the structurally weak periphery.
So far this year, analysts’ forecasts are being revised upwards, both in GDP and in terms of earnings, but we think estimates are too high in light of the headwinds facing Europe equities. Some indicators suggest that European stocks are just as expensive as US markets, but with a lot more risk attached. We therefore maintain an underweight to European equities.