There has been a notable uptick in concern about the viability of the European project in its present form. There are two main factors in this. Firstly and most imminently the Greek crisis and to a lesser extent the prospect of the United Kingdom exiting in a couple of years’ time should the Conservatives win the general election and hold a referendum.
Major stock markets around Europe including the FTSE 100, CAC 40 and IBEX 35 fell yesterday, apparently spooked by Greece. The issue of whether the country will be able to reach an agreement with its main creditors lead by Germany on how its debt obligations will be treated has been a slow burner, but the fuse seems close to burning down to the end now.
The Eurogroup meeting yesterday refocused markets on the issue and the complacency over a possible Greek default or exit from the single currency appears to be lessening.
The reality is that nothing of substance was achieved last month when the parties decided to kick the can down the road for another four months having been miles apart in the negotiations, and the latest meeting has reinforced this in the minds of investors. If a messy collapse is the ultimate result, nobody truly knows the impact that will have across the continent.
Then there is the fact that the ‘big bazooka’ of sovereign QE has now been used so the ECB has no real weapons left in the armoury if the programme does not deliver as much of a lift as hoped.
Quietly bubbling away over the other side of the English Channel the UK general election has crept into the consciousness of investors over the past few weeks in a way that was not so in January when Syriza took power in Greece and Grexit first reared its head again after the long hiatus following the 2011 flashpoint.
The latest polling data has put a different complexion on matters in the UK. Labour had held very healthy leads for most of the past five years but things have narrowed significantly during the early part of this year, making a Conservative victory and the promised ‘in or out’ referendum a possibility.
The ‘poll of polls’ has the Conservatives on 33% and Labour on 34% meaning the most likely outcome is a hung parliament, but with two months to go the direction of travel is in the Conservatives’ favour.
Although not in the single currency, the increasing prospect of one of the big three European economies exiting the bloc could be highly destabilising to the whole continent if it is not handled well.
There are nevertheless very strong data-driven reasons to pile into European equities. Economic growth figures in positive territory are trickling through, the QE programme is vast in total size and timeframe terms while trading multiples even on high quality European companies are way down on American and some British counterparts.
Interest rate rises in the US and UK seem to be close, with the low oil price the only thing holding them back. When they do come through that should add to the attractiveness of European equities in relative terms.
There is an easy upside case to make, providing you believe the Greek situation will be resolved without significant fallout and a potential British exit from the EU will not materialise.
All this means that deciding on the size of a European equities allocation seems to be very high stakes game. Either big gains or heavy losses are likely to be made depending on what you choose and how the rest of 2015 plays out, with nothing in the middle ground between those two outcomes likely.
