Brian Tora puts his thinking cap on to try and puzzle out how the deal or no deal scenario might affect investment in European markets
With so much of the media focused on what our negotiations to leave the European Union might mean to us here in the United Kingdom, especially if no deal is reached, it is too easy to forget that there is another side to this particular coin. The twenty seven remaining states in the EU will be impacted by our departure. Moreover, it is not just what is happening with the Brexit talks that is having an influence on markets across the channel. Political upsets in Germany, France and – crucially – Italy are all having a bearing on how European shares and the single currency behave.
The two dominant markets in the EU, leaving us aside, are Germany and France. Their respective performance this year tells an interesting story. In a year of fluctuating fortunes, the Dax 30, Germany’s principal benchmark, is down by around 5%. The French equivalent, the CAC 40, is some 4% higher on balance, having been up by nearly 7% at one stage. As it happens, both economies have been doing reasonably well recently. Indeed, the euro zone put on something of a spurt during 2017, even if more recent economic data has indicated progress has slowed somewhat.
Arguably the UK leaving the EU without a deal could be just as damaging to the remaining members as it could be to us in the UK
Deal or no deal?
Arguably the UK leaving the EU without a deal could be just as damaging to the remaining members as it could be to us in the UK. We buy more from Europe than we sell to them. Much has been made of the effect our departure might have on our domestic car industry, but just think of how sales of Mercedes, BMWs and Audis might be affected if high import tariffs are introduced. Perhaps by the time you read this a deal will have been cobbled together, but it is worth bearing in mind that Brexit will have implications in a number of areas.
A mixed bag
If European economies are generally not doing too badly on average, the picture between individual countries is more varied. Take unemployment as an example, which in the single currency zone is running at around 8% – pretty much double that of the UK and US. Europe’s jobless are by no means evenly spread. Greece, Italy and Spain all have particular problems, particularly with youth unemployment. Germany, in contrast, has near full employment, but arguably their manufacturing industry is the biggest beneficiary of the single currency, so understandably they have been determined to hold this bloc together at all costs.
Greece was not allowed to leave the euro when they got into difficulties and Italy has been told in no uncertain terms that reverting to the lira is not an option for them. Yet the new government in Rome has made no secret of the fact that it views such a move as a means of reinvigorating a stagnant economy. With discussions over the nature of the Italian budget serving to upset market sentiment in Europe during early October, it is clear that how the European Union manages its problem members will remain a crucial feature in determining how markets move.
What does it mean for investors?
What should investors be doing about Europe? On the face of it, European shares appear fair value. They are certainly cheaper than those in the US – by quite a margin. Indeed, while European shares generally trade on lower valuation criteria than their American counterparts, the effective discount is presently around twice as great as the longer term average. Whether this makes European shares cheap or US shares expensive is a moot point.
What is clear is that most fund managers operating in European markets adopt a stock picking approach to portfolio construction. They would argue that there is a wealth of opportunity amongst world class businesses, generally rated more favourably than their overseas competitors, making the apparent disparity between the fortunes of individual nation states of less concern. I hope their optimism is well placed. Personally, I will feel more comfortable once this whole Brexit matter is finally put to bed, though with the rise of populism making some governmental decisions less predictable, the future for Europe overall remains obscure.
Personally, I will feel more comfortable once this whole Brexit matter is finally put to bed, though with the rise of populism making some governmental decisions less predictable, the future for Europe overall remains obscure.
Shaken and stirred
Meanwhile, on the other side of the Atlantic, US 10 year Treasury yields have broken out of their recent trading range on the upside. With the Fed set to continue monetary tightening and raise rates, some forecasters are predicting that yields could rise to well over 4%. While on a longer term historical basis this may not sound excessive, it would mark a dramatic change on what we have become used to over the past decade or so. Global bond funds have been seeing outflows in recent months and there is evidence to support the contention that we could be in a secular bear market for fixed income securities. Bonds may well be worth revisiting in the weeks and months ahead.