By Stephanie Flanders
At the start of the year we felt strongly 2014 was going to be “showtime for the global recovery”, stock market returns were going to be more closely linked to economic fundamentals, and the global economy would come good on growth expectations already built into market prices.
The US has more or less delivered on expectations, but large parts of the world have not, especially the eurozone. The near absence of upward pressure on wages in the developed world and continued falls in commodity prices have fuelled fears global disinflationary pressures have become entrenched.
In the face of these disappointments, a market correction is not fundamentally surprising. Nor is it a shock to see stock prices in Europe more affected than elsewhere: the Euro STOXX has fallen nearly 10% since its high in June, compared with a 3.2% fall in the S&P 500 and 4.9 per cent in the ACWI.
Investors are right to be concerned about the pace of Europe’s recovery. This weak economic backdrop, along with continued decline in the inflation rate, have worrying implications for highly indebted countries such as Italy or Spain.
Are European policy makers doing enough to improve the situation? In September the European central bank made clear its commitment to taking more action to reflate the economy. That will be crucial. But for the ECB’s policies to work, businesses also need to feel confident in the future of the recovery, meaning governments need to do their part to support demand and raise Europe’s potential through structural reforms.
Rising private investment and employment in Spain shows efforts to improve competitiveness can translate into faster growth. It is interesting the Spanish stock market has been less hard hit by recent turbulence than many other European markets.
In the coming weeks there are several factors which could help turn European sentiment. The completion of the ECB’s Asset Quality Review (AQR), the 7% weakening in the Euro since June should start to be reflected in European corporate earnings: 45% of revenues for European large cap companies come from abroad.
We are also beginning to see small victories on the reform front, such as Italy’s recent vote to advance Matteo Renzi’s Jobs Act; and major reforms from French government.
“They usually do the right thing, but only after exhausting all of the alternatives”. Winston Churchill once said about America. Today we might say it was a better description of European politicians. They have a habit of making the crisis worse, before finally delivering on a plan to make it better.
I expect to see a lot more bad headlines coming out of Europe as Germany, France and Italy lock horns over their budget policies, and investors look at the mountain of public and private debt in Italy, Spain, Greece and wonder, not for the first time, whether it can really all be repaid.
Investors in European assets are not in for a smooth ride. But ultimately, it is a good thing if investors are now focusing a more on challenges and opportunities facing Europe’s recovery, and a less on central bank actions. Long-term investors have the luxury of looking through this volatility, to see the bigger picture. For all the fear infecting markets, that big picture is not so different to a few months ago.
Stephanie Flanders is chief market strategist for the UK and Europe at JP Morgan Asset Management
Comments