Germany’s DAX has risen 18% during the first quarter of the year breaking the 12,000 barrier, France’s CAC 40 rose 15% to go north of 5000 points and Spain’s IBEX 35 has risen 8% to around 11,500.
The question now being asked by investors from wealth managers handling hundreds of millions to individuals with 2000 quid in an ISA is whether there is further to go after this stellar start to the year.
With such sharp rises coming over the past three months it could be argued that the near term upside is close to, if not fully, priced in. There are however strong arguments as to why there could be a long way to go still.
A big factor in determining which of these opposing views is closer to the truth will be how the great European quantitative easing experiment plays out.
As noted by Smith & Williamson’s chief investment strategist Philip Lawlor, the QE programme in Europe will not necessarily play out in a similar way to the United States, or result in such a sustained rally.
“Whatever one may feel about the backwash from quantitative easing in the US where, like the Hotel California, checking out may prove a lot more difficult than checking in, it has done as intended; broadly supporting growth,” he said. “But the Eurozone is not the US. They do things different there, and the transmission mechanism for QE is different.”
Lawlor sees three key differences. Firstly, US mortgage rates are linked to bond yields and QE lowered yields therefore lowered mortgage rates. Eurozone rates do not have this relationship, so the US housing market boost seen is unlikely to be replicated in Europe.
Next there is the fact that 70% of US corporate debt funding comes from the bond markets, the rest from banks. In Europe the proportions are reversed. While QE should make it cheaper to issue bonds in the eurozone, it will have less of an impact on companies’ balance sheets in Lawlor’s view.
Finally there is the ‘wealth effect’. US QE supported equities markets, which helped the wider economy because of high share ownership levels. The effects of a rising equities market will be less widespread in Europe because only 13% of Germans own shares for example, compared to some 52% of Americans. Logic therefore dictates the impact seen in the US will be ‘more muted’ in Europe, Lawlor said.
The other major determinant of how long and high the rally goes is likely to be how long the oil price stays low. Nobody seems to be confident in predicting when the price will head back up significantly and when it does happen it could pull the rug from under a European recovery.
On the positive side something else to consider is that some believe there is a lot more money already pegged for European equities funds to come in and push prices higher.
As reported here, JP Morgan’s Tony Lanning is one such investor. He argues that European and British investors have been quick to act but in other parts of the world the money moves slower, although it is definitely on the way.
If a wave of Asian or Middle Eastern money does follow the early European and British money into the eurozone that could push the DAX and co onwards for a further significant period.
Whichever way you look at it, European equities are far from a one direction call.
