Fuelling concerns further are ongoing events in Eastern Europe, potentially dampening European business activity. In response, equity investors have been voting with their feet. Both Germany’s DAX and France’s CAC have been down as much as 10% from their most recent mid-summer 2014 peaks.
Contrary to some investors, we read the recent data differently. Importantly, seasonal factors influenced the second quarter data, so a pull-back in activity should have been expected. First quarter growth was unusually strong as benign weather conditions boosted construction activity, especially in Germany.
Looking forward, while Russia is likely to have an impact on the short-term outlook, we believe that there are forces underpinning a modest recovery for the remainder of 2014. Consumption growth remains strong, supported by rising employment. We are also encouraged by a thawing of credit conditions as banks lower borrowing rates for corporates and households.
The recent weakening of the euro from a three-year peak will be a source of relief for the region’s manufacturers. Furthermore, while investors fret about Europe entering a deflationary spiral, the ECB has more tools in its armoury to prevent this scenario from happening. However, we do not expect the ECB to move in the near-term.
We remain overweight European equities given decent valuations and current negative sentiment. Within portfolios, we have rotated capital towards large-cap global exporters who stand to benefit from a weaker euro. We are also overweight the banking sector, which in aggregate continues to witness improvements in underlying profitability.