World Investment Outlook – Chapter five: Western Europe

Politics

The year 2019 began with Donald Tusk, the outgoing President of the European Council, saying that he thought there would be a “special place in hell for those who promoted Brexit without even the sketch of a plan”.

Relations with the UK could remain tense for some years to come but Britain is not on its own in this respect. The EU’s relations with America are fraught, and there remains a distinct frost between the bloc and Russia and Turkey, too, so the new Presidents of the European Commission and the European Council - Ursula van der Leyen and Charles Michel respectively - are likely to have their hands full.

But with relatively few elections scheduled for 2019, the EU will be able to devote plenty of energy to all of these issues and Brexit in particular. The bloc’s large collection of coalition governments will be trying to cement their positions and fend off anti-EU nationalists - notably in Germany, where the build-up to 2021’s federal elections is likely to start early, especially as four-term Chancellor Angela Merkel is stepping aside.

Having stepped down as leader of her centre-right Christian Democratic Party (CDU) in 2018, ‘Mutti’ has already declared that her 16-year term as Germany’s elected leader will end with the 2021 federal elections. Annagret Kramp-Karrenbauer will lead the Christian Democrat-Christian Social union coalition into the poll.

In 2020, notable elections that are planned include those for the Greek and Icelandic presidencies, as well as the French Senate. The German, Irish and Dutch general elections of 2021 mean the following year could be much more important, although that may largely depend upon how Brexit goes.

Economics

One interesting trend among all of those election results and subsequent coalitions is the emergence of left-leaning, Social-Democrat-led governments (with Greece as a notable exception and there will be more on that later). This suggests that electorates are weary of austerity and looking for more expansionist, pro-growth policies (such as those already launched in America under the Republican President Donald Trump and, in theory, the Conservative Government leader Boris Johnson in the UK).

It does therefore seem that fiscal probity is out of favour and borrowing and spending are back in fashion. Italy is still chafing against the budget restraints placed upon it by Brussels (even if talk of issuing bonds in a currency that would run parallel to the euro quickly faded away); Germany is openly debating the merits of Chancellor Merkel’s so-called Schwarze Null balanced-budget policy; and the European Central Bank’s new President, Christine Lagarde, is already joining the chorus as she calls for more budget flexibility.

This may reflect the EU’s soggy growth profile and weak inflation, as well as growing concern that monetary policy is reaching its limits (although the former chair of the International Monetary Fund does already appear to be laying the groundwork for interest rates to move deeper into negative territory). Keynesians will also argue that if ever governments were going to borrow, it would be now, when annual deficits are relatively low, interest rates are at historic troughs, inflation is way below the 2% target and GDP growth is anaemic.

EU inflation remains well below 2% target

Source: Eurostat

GDP growth is patchy at best

Source: Eurostat

This state of affairs may also explain why outgoing ECB President Mario Draghi delved back into his bag of monetary tricks just before he stepped down. In September, barely 10 months after he declared victory in his battle to stoke growth and inflation, he relaunched Quantitative Easing and began to cut interest rates once more.

The ECB has begun to loosen monetary policy again

Source: ECB, FRED – St Louis US Federal Reserve database, Refinitiv data

For all that Draghi can claim success in his quest to preserve the European dream and the single currency, his legacy to Ms Lagarde is by no means an easy one, even if some of the EU’s woes are not of its own making, with bellicose American trade policies an unwelcome complication.

Markets

The benchmark Euro Stoxx equity index is still no higher now than it was in December 1999. Worse, the Euro Stoxx banks index is back at 1993 levels. This has uncomfortable echoes of the ‘lost decades’ suffered by Japan since the bursting of its debt-fuelled property and stock market bubble in 1989.

Europe’s key stock indices have not progressed for 20 years – or longer

Source: Refinitiv data

It is therefore easy to paint a gloomy picture. But some investors may take the view that little or none of this constitutes ‘news’ and that, if an index is where it was 20 years ago, there may be some contrarian value to be had.

Greece is already starting to surprise on the upside, even if it faces a long road back from emerging to developed market status. And Western Europe was the third-best performing region in 2019, out of the eight major options available to investors, in total-return, sterling terms.

Western Europe was the third-best performing region in 2019

Source: Refinitiv data, based on the Stoxx Europe index. Total returns in sterling terms.

In addition, Western European stocks still trade at a discount to their global peers, although, less encouragingly, this is not unusual if investors look back over time, especially relative to the all-conquering US equity market.

Data from Bloomberg does, however, suggest the Euro Stoxx is cheap relative to its own history on an earnings and dividend yield basis. European equities also offer a deep pool of dividend-paying stocks and a respectable yield of 3.8%.

These two factors may tempt some but they also beg the issue of what will prompt investors to reappraise Western Europe as a portfolio option.

A settlement to the vexed issue of Brexit is one possibility but that would still leave the EU facing fractious regional political issues in Belgium, Spain and Italy to name but three, as well as the economic risks that lurk in Spain, Italy and Germany. Some improved economic momentum would be very helpful, if the bloc is to really shake off the ‘Japanification’ tag, especially as that would also soothe unhappy electorates.

Russ Mould, AJ Bell Investment Director

Next chapter

Read more from our World Investment Outlook 2020 series:

World Investment Outlook - Chapter one: UK

World Investment Outlook - Chapter two: USA

World Investment Outlook - Chapter three: Japan

World Investment Outlook - Chapter four: Asia

World Investment Outlook - Chapter five: Western Europe

World Investment Outlook - Chapter six: Emerging Markets

These articles are for information purposes only and are not a personal recommendation or advice.