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Structural shifts in Europe: a Quality bias could pay dividends

The main driver for the European economy in recent decades has been Germany with its efficient export industry but upheaval from trade tensions and structural changes to the auto industry could mean that the growth engine moves across the border.

Author Terry Wood, Head of ETF Portfolio Management (EMEA)

Germany losing pole position

The European Commission recently cut economic growth forecasts for both 2019 and 2020 in its autumn projections, these cuts being driven by a lower contribution from Germany.  Their expectations are for the French economy to expand at a faster rate than Germany, and for Italy to remain subdued. Could this develop into a longer-term economic theme? 

France to take the driving seat

The signs of a shift in consumer behaviour to electric-based cars is an early indication of environmental and sustainability issues driving change. The demand for cars in the developed world has been falling in recent years, and this headwind for the industry is compounded as profitability within green technology creates new challenges. The battery of an electric car is most likely to be manufactured in Asia and is a far greater proportion of a car’s value than a traditional gasoline version. Germany’s automobile challenges could see France take the driving seat for growth, especially as the pro-business agenda of President Macron is starting to gain traction. 

Important reforms to make the French labour market more flexible and competitive are progressing, which include new rules to make it harder for the unemployed to claim benefits with the aim of encouraging more people to return more quickly to the workforce. This has proved not to be popular and rioting in Paris may not be the best advertisement for political stability, but it has forced Macron to cut taxes and, with a weakened opposition, he is free to push ahead with his major reform programme.

Italy caught in the headlights again

A broader European economic slowdown will highlight the issues again in Italy, grappling with very high levels of public debt and populist right-wing political pressures. Eurozone growth has been disappointing and even though the European Central Bank added further monetary stimulus in September, such action may have limited impact. Trade tensions and Brexit concerns remain high on the agenda so a defensive tilt could be appropriate for investors in this region. 

A Quality bias could keep you on the right track

The BMO MSCI Europe ex UK Income Leaders ETF, which screens first for quality companies and then for relatively higher dividend yield, aims to offer a defensive approach while still providing an attractive income stream. The fund tracks the MSCI Europe ex UK Select Quality Yield Index, which typically leads to a selection of companies with robust business models as profitability, earnings stability and leverage are the drivers behind MSCI’s quality criteria. Holdings where we have recently been overweight relative to the MSCI Europe ex UK Index that have driven fund performance include Sanofi, Siemens, Novo Nordisk and Unilever. A GBP hedged version is also available for those who may have currency concerns or anticipate a soft and orderly Brexit early next year that could shift European exchange rates.