Will Europe's political changes present investment opportunities?

The landslide victory by pro-European Union (EU) candidate Emmanuel Macron in the French presidential elections added to the feeling that voters in Europe are stepping back from the political brink. It compounded the results from the Dutch elections, which also gave some indication of a resurgence of positive sentiment towards the EU and establishment candidates. So, with Europe’s political calming supported by an upturn in economic fortunes within the EU, is it time to consider investing in the region?

European business confidence is broadly near the best levels seen since the financial crisis

Corporate earnings are set to grow after some five years of relative stagnation, particularly in manufacturing and banks. Eurozone corporations are benefitting from improving demand from within the region and internationally – principally from the US and China.

European bank lending has also somewhat improved, albeit off a low base. European governments are moving away from the aggressive fiscal austerity packages that characterised their first response to the crisis. Indeed, the European Commission has cancelled fines and extended deadlines for countries breaking deficit rules – all positive signs.

But there’s immigration challenges, structural issues and an income squeeze to contend with

A combination of poor wage growth (as we’re also seeing in Australia) and increasing inflation is squeezing European consumers. Unemployment is still uncomfortably high in some nations – France at 10 per cent, Italy at 11.7 per cent, Portugal at 10.5 per cent, Spain at 18.8 per cent and Greece at 23.5 per cent. And wages are unlikely to grow until this slack in the labour market unwinds, and as such, consumer spending will remain weak.

In the long run, Europe remains hostage to its demographics – an ageing population and shrinking workforce. Despite the demographic issues, the ‘easy’ solution – immigration – is politically unpalatable. Europe is yet to solve the tensions the refugee crisis created, notwithstanding the flood of refugees has for the moment diminished.

Structural issues within the EU – created by fixing the currency without means of fiscal equalisation – also have not disappeared. The Euro is arguably too strong for the economic wellbeing of most of its members, with perhaps the exception of Germany, and even they are seeing growth in export orders start to fall – a result of relative Euro strength against the US dollar in recent months.

As investors, it’s important to be cautious as you evaluate opportunities in Europe

In the short run, there is an easing of anti-EU tension and clear signs that the Eurozone economy is recovering. Further, there does not seem to be any real likelihood that the European Central Bank will tighten in the medium term – the zone’s economy is still not firing on all cylinders, and inflation remains subdued. There is also relative value in European shares, trading at around a 20 per cent discount to the US.

This combination of an improving outlook for growth internationally and in the Eurozone, continued low Euro interest rates and lower relative stock valuations is likely to support European equities in the near term. Those companies with exposure to both European and international markets (especially the US and China) should benefit.

But, in our view, these value drivers are relatively short term – tactical rather than strategic – and we remain concerned about the structural issues afflicting Europe, the geopolitical tensions, and especially the demographic headwinds. This makes it harder to identify longer term opportunities. For now, while we recognise that conditions in the region are improving, we recommend caution about taking on European exposure on a longer term view.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.
 

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Patrick Broughton

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With 25 years’ global investment banking experience in a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange, Patrick Broughton is charged with chairing the Dixon Advisory Investment Committee.

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