Investor attitudes to the single currency bloc took a hit over the late summer and early autumn as fears grew that another recession was on the way and the falling oil price would lead to deflation across the region. In an era where the media typically focuses on the negatives, it is worth reminding ourselves that while there are very real risks to the eurozone’s growth story, there are some reasons to think that the eurozone’s B-side might sound a little more upbeat than what is currently playing. Here are five things (in no particular order) that investors should consider that are not always reported by the media.
1. Less austerity. The eurozone was subject to three years of belt-tightening as politicians at the national and supranational level imposed a regime of spending cuts to reduce deficits and tackle growing debt levels. It quickly became apparent that spending cuts without growth would never really address the fundamental causes of the debt crisis and that greater emphasis should be placed on growth policies. Thankfully, this means that austerity is no longer as severe and is much less of a drag on economic growth.
2. Slow but steady reform. A pro-growth stance requires policy reform to make foundering economies more efficient and ultimately more competitive. The reform process had been hampered by the political environment, but an extended period of political stability gives governments a greater chance of moving things such as labour market reforms through the legislative process. There are already some examples of reform improving the growth story at the margin. In Spain, for example, private investment is rising and employment, though still high, is improving. This provides some comfort that reforms can be translated into higher rates of economic growth. Meanwhile, small victories such as Italy’s recent vote to advance Matteo Renzi’s Jobs Act, mean the reform agenda is progressing, albeit at a slow pace.
3. A central bank which stands ready to act. The president of the European Central Bank, Mario Draghi, came out loud and clear at the November meeting, firmly putting to bed any thoughts that his leadership was being challenged. Mr Draghi also clarified some of the issues that had been causing the market consternation. First off, he stated that he wanted to return the balance sheet to the same level as March 2012 which is very clearly a trillion euros from where it is today. But, perhaps, more importantly, he confirmed that preparations for further easing were already under way (if needed) and that more action would be triggered if the current economic malaise did not look set to improve.
4. A turn in the credit cycle. So far, the eurozone ‘recovery’ has been devoid of credit creation as banks de-lever their balance sheets. A tighter regulatory environment has forced banks to improve capital ratios and jettison anything that looks like risky lending. The Asset Quality Review added to scrutiny and may have restricted the lending practices of many banks. European companies, especially the small and medium-sized ones, rely heavily on bank lending for financing much more than comparable companies from the US, which are more able to tap into capital markets. However, now that the AQR has ended, that burden has been lifted from the shoulders of many banks, and while lending may not skyrocket, a marginal increase in lending could be expected. This is corroborated by the ECB’s bank lending survey which shows that demand for loans from both households and business is on the increase and that banks are making those loans more readily available.
5.Valuation. European equity markets are not expensive at the index level. The MSCI Europe ex-UK Index was trading at 14 times price-to-forward earnings at the end of October and just above the average for the last 15 years of 13.9 times.
Investors should remember that equity markets are forward-looking and will react to the prospect of better future growth, rather than waiting for it to appear. The outlook for eurozone growth and inflation may not be a chartbuster, but markets might just have a few reasons to change the tune.
Kerry Craig is global market strategist of JP Morgan Asset Management
