The time to act has come and we think it is clear that Mario Draghi and the ECB now understand that they need to follow up their words with decisive action.
They are rightly worried that deflationary forces could render the reformist efforts of European politicians pointless, as without inflation helping to erode the teetering debt piles on the European periphery, the region will continue to struggle to grow and will go back to its role of an anchor on global growth.
Action is undoubtedly necessary as the Euro has strengthened again this year, providing further deflationary pulses and limiting the vital export sector that fuels European growth. Our snap reaction to today's announcements would be that Mario Draghi has bought Europe more time to get its house in order.
Draghi's actions are targeted towards getting money flowing through the financial system and fixing the clogged arteries that are currently holding back growth; he has effectively told the banks to lend or the ECB will circumvent them. He has also basically suggested that the ECB might well create financial instruments so they can buy them themselves. We live in extraordinary times. I think if you were to give him a call right now he would probably offer you a loan for a house or a car.
Our portfolios are currently overweight the European periphery, where we particularly favour the equity markets in Spain and Italy. While everyone focuses on the headline politics, we instead admire cheap valuations and long term profit recovery potential that the Periphery promises and today’s moves by the ECB should help to support those markets. Peripheral European companies’ share prices have undoubtedly recovered but as yet they do not discount the sort of profit recovery that we should expect.
Indeed, there is the potential for European corporate profits to follow the same trajectory that their US peers took over the last three years. While general European valuations now look “up with events” there is certainly the possibility that improving earnings, as the economy recovers, could make valuations actually much more palatable.
We currently favour those sectors, companies and regions where valuations are attractive and the recovery potential seems highest. That leads us to the financial sector, industrial companies and consumer discretionary businesses. Two current top picks in our portfolios are Neptune’s European Opportunities fund and River & Mercantile’s World Recovery fund.
As well as being supportive for peripheral European equities, the negative deposit rate imposed upon deposits with the ECB should also provide support to all high quality fixed income markets, as the banks will be desperate to make a return on their assets.
In conclusion, Draghi's actions today confirmed that he is willing to back his words with actions and he has made it clear that he will do 'whatever it takes' to stave off deflation and get the European economy moving forward. His actions are undoubtedly bold. It is about time…
