The EuroStoxx 50 index is now at the lowest level it’s been since 2012. It’s below the highs seen in 2009. Of course, it’s possible that we’re going to enter another major recession/depression and it continues on down to new lows. Possible, but frankly not very likely, as there is precious little evidence of slowdown, never mind recession in Europe. Sure, the US and Chinese data have been driving things, and there is no doubt that there has been some evidence of slowdown in those economies But even there, growth is positive, and we have seen plenty of uneven growth patches in the US in the quite recent past to make me doubt that the slowdown will last very long. After all, part of the cause of the slowdown is commodity -particularly oil – related, and there are positive effects from lower commodity prices on consumer demand (and on the cost base of many firms) which will take time to come through but will have a growth positive impact down the line. There are clear weaknesses in the world economy in the oil dependent economies – notably Brazil and Russia – but lower oil prices, when supply driven as most agree they primarily have been – are at worst ambiguous in their implications for global growth longer term. Now, as we all know confidence is fragile and a general loss of confidence can lead to a recession even if there is no sensible cause. But consumer confidence is not generally weak by historic standards in Europe or even the US, and as long as that is the case this has to be considered a massive buying opportunity for risky assets, and European equities look the most obvious.
For those who doubt that there is real value, consider the following.
Eurozone GDP at market prices is 8% above the peak level seen in 2008, and 13% above the trough in 2009.
Bond yields are dramatically lower than in 2009. 10 year government bond yields and 10 year EUR swaps are 2.5%-3% lower than in 2009. Most peripheral bond yields are dramatically below their highs. This means that the equity risk premium is at remarkably high levels. You’re being paid about 4% on top of capital appreciation to hold European equities.
Eurozone PMI data is showing almost no sign of slowdown. Sure, the January data was the lowest in 4 months, but 53.6 for the composite PMI is a very respectable number by recent standards, very close to the highs seen since 2011 and broadly indicative of GDP growth in the 0.4% region q/q (according to Markit).
So why are equities so weak? Well, there are some concerns about banks, though it seems extremely unlikely that exposures to commodity producers are going to bring them down given the improved capitalisation and reduced risk profiles. But mostly this is panic, flow related moves perhaps with some liquidation at the beginning of the year from some big players. But the economy would have to be a lot weaker than this to justify the weakness of the equity markets. Maybe it will be, but a lot is now in the price.
Of course, you have to be prepared to wear it for a bit if you’re going to make a value based call and buy European equities and other risky assets here. But it is the logical call at these levels.
From an FX perspective the risky currencies are obviously the ones that have the most potential to recover. But it’s not as simple as it used to be, as a lot of the traditionally risky currencies are justifiably lower because of commodity price weakness. And on a relative basis, the USD, which has been one of the most risk positive currencies in the last year, doesn’t have a huge amount going for it on the latest data. The most obvious victim of all this has been the SEK, which ha been sold off heavily because people had it as a risk positive play (though nowadays with negative short term yields it’s not at all clear at this ought to be the case), and I like the SEK here against the EUR and the USD. The EUR may start to worry about ECB action in March especially as we have hit the key retracement levels from the October-December decline in EUR/USD. GBP continues to worry about the referendum and possible Brexit. So FX in general is tricky. But the recovery in the CHF looks like a selling opportunity too.