Germany is the region’s economic locomotive but has experienced a plunge in industrial manufacturing. Business confidence in France is very weak and people are mistrustful of investing in the country. Real estate prices in Paris have stayed stable, but the price of holiday houses is 20% to 30% below what it was in 2007. Italy has not yet implemented the structural changes it needs.
We are not convinced that the ECB has taken sufficiently timely measures to fight low-flation. European countries are no longer competitive on the international stage, which exposes them unduly to foreign demand trends and external shocks. The Eurozone has a 40% share of international trade so a competitive currency is very important.
The value of the euro is key to the Eurozone’s short to medium term health. Depreciation is the only way the region can raise its exports and boost competitiveness. The euro is likely to be much lower than it is today in 12 to 24 months’ time, particularly against the dollar when Fed policy starts to encourage money to flow back into USD.
Euro depreciation, plus the plans the new EU president has for revitalising the region, means that recent poor growth should not persist. But the wall of worries facing investors will create much volatility from September onwards.
Commodities: the world’s Achilles heel
Most of the countries involved in geopolitical troubles, such as Syria, Ukraine and Iraq, do not make large direct contributions to world economic growth. The Achilles heel of the global economy is their impact through crude oil, gas and wheat exports. Any increase in commodity prices can be seen as a global tax which will substantially reduce the economic recovery.
Crude is split at the moment. Brent, the international reference for crude oil has bumped against a ceiling whilst West Texas Intermediate has some room to increase. However, heightened geopolitical tensions in Iraq might push the crude price up. Iraq produces 3.4m barrel of oil a day, Europe uses 1.5m a day. We remain negative on gold prices because we foresee an acceleration of the US economy and constructive investor sentiment
Equities: preference for European banks and autos
There are strong grounds for earnings optimism for European companies. Within European equities we continue to prefer banks and autos where valuations are not stretched. The anticipated results of the asset quality review in November will give room for further tightening of European bank spreads.
US companies have almost $2trn in profits stockpiled offshore (according to a Bloomberg News review of securities filings from 307 corporations), and US merger and acquisition activity should continue, providing a floor on equity valuations. Our preferred sector in the US is IT, which typically gains momentum during the middle phase of the cycle.
