3rd August 2015
Hermes Sourcecap Europe ex-UK fund co-manager, Tim Crockford, assesses four key factors that will influence the direction of European equity markets from here…
Greek drama masking European recovery
While there are still hurdles to overcome in the Greek situation, we are encouraged that the market is moving on from the drama that has been dominating the news agenda. This will allow investors to focus on the recovery that is happening – and accelerating – in Europe. There has been a rash of positive news across Europe in recent weeks, which has been masked by the Greek headlines. This includes June car sales which showed yet more signs of acceleration in key European countries, with France and Spain to the fore. European airline traffic rose 4.9% in May, while Schipol airport in Amsterdam saw its strongest traffic growth since May 2011. Staffing markets continue to recover, with France showing its highest reading since Sept 2011. Loan demand across the Eurozone, particularly in Italy and Spain has started to show tentative signs of improvement.
Policy arbitrage opportunity
Janet Yellen’s testimony to Congress a couple of weeks ago reinforced the message that the Fed is still committed to raising rates this year. We expect rate rises to start with a 25bps hike in December of this year, as an inflation pick-up would make a rise easier to justify. While we have seen gains in employment this year, we continue to see lacklustre and volatile growth in manufacturing, inventory build-up and uninspiring retail sales gains, and therefore think that the Federal Open Market Committee (FOMC) may have to reconsider the trajectory of its Fed Fund rate rises as we get into 2016.
Our view remains that, unless the data does turn the wrong way or we have a macro shock such as a Grexit, we will continue to see increasing policy divergence, with the US Federal Reserve and Bank of England planning rate rises, and the Bank of Japan refraining from increasing stimulus beyond the current JPY 80trn per annum rate. Indeed, Draghi appears to be the most dovish of the developed economy central bank heads. This opportunity for “policy arbitrage”, combined with a continued recovery driven by the European consumer, will continue to move European equity markets higher as we move out of the volatile, thinly-traded summer period and further into the second half of the year.
As a far larger driver of the global economy than the other main headline-grabber, Greece, we are concerned about the recent market volatility in China, and remain cautious about the potential worsening of the macro economy in the near term. Since the reported official figures’ reliability are questionable, we prefer to observe what companies with exposure to the region report over the course of this earnings season, and so far we’ve had SKF profit warn as a result of Chinese weakness and BMW saw deliveries decline in May for the first time in over a decade, via its Brilliance joint venture, which saw profits slump 40% in the first half of the year. We continue to monitor corporate results through the earnings season; however, the initial signs are not encouraging.
Mario the Market Whisperer
Once again, Mario Draghi’s words have calmed markets, and the guardian of the monetary union appears to have managed to firewall Greece’s issues from spreading into the wider market, with credit spreads remaining fairly tame, even at the height of the Greek drama, and narrowing towards pre-crisis levels in the wake of the recent agreement. Unlike Draghi’s “whatever it takes” speech three years ago, his most recent address was supplemented with action, as the European Central Bank (ECB( head announced another ELA extension (EUR 900mn) and even suggested that Greece’s bonds may soon be included in the ECB’s QE programme. As discussed above, we expect the ECB to remain the loosest of the developed nation central banks.