Why Europe is the darling stockmarket of 2015

This article is part of
Summer Investment Monitor - June 2015

Europe has been the darling stockmarket of 2015, but can it continue to lead the charge through the second half of this year?

The path to a stronger Europe seems well under way with the combined impact of structural reforms, accommodative monetary policy and the decline of the euro, but given how far the market has run, now is a good time to ask whether there are still significant opportunities for equity investors.

Improvements in the underlying economic environment would suggest there are. Economic indicators for Europe hit their highest level in two years during the first quarter of this year, before receding. Although momentum remains fragile, it still stands out relative to the US and the 10 largest global economies.

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There are several reasons for this. First, less austerity. Realised adjustments in terms of structural budget deficits across Europe have borne fruit, since there are now only 12 countries out of 28 that remain under the control of the European Commission for their excessive deficit, 15 fewer than at the peak of the crisis.

The weight of austerity measures therefore has decreased overall in recent months in the euro area (0.9 per cent of GDP in 2015 against 3.7 per cent in 2011), and this hinders growth less.

Second, structural reforms. Many European countries have taken steps in recent months to fundamentally reform their economies and make them more flexible. The regulatory framework for the labour market in many cases has been simplified and made more flexible. As a consequence, the level of protection for employees has declined to better divide the economic risk between companies and employees and promote job creation. Moreover, these combined measures have helped to slightly reduce the unemployment rate of 11.7 per cent a year ago to 11.1 per cent today.

The third pillar of support has been the declining euro and accommodative monetary policy. The ECB is fighting deflation effectively with its ambitious quantitative easing programme, and the euro has lost almost 30 per cent of its value against the dollar in 12 months.

As well as trying to stimulate inflation and growth with its asset-purchase programme, the ECB is attempting to stimulate lending in the euro area to provide the necessary oxygen to the economic lungs of the region – the small- and medium-sized enterprises (SMEs) that represent two-thirds of employment in the euro area.

Fourth, the icing on the cake of all this has come from the fall in oil prices, which has acted as a boon for the European economy, which imports most of its energy needs. The fall in oil prices returns purchasing power to consumers, illustrated by retail sales that have risen 1.6 per cent year on year, and by the fact that domestic demand has been one of the key contributors to growth in the first quarter.

The European economy seems to have entered a virtuous cycle that has drawn the attention of many investors, in spite of continued anxiety over the Greek debt negotiations.