7 min read 10 Feb 20
Summary: Lately a growing number of indicators have suggested that the European economy might be out of the woods, heading towards a more robust recovery. For instance, while European inflation remains significantly below the ECB’s inflation target of close to but below 2%, it is worth highlighting that the year-on-year headline rate has in fact doubled from 0.7% in October 2019 to 1.4% in January 2020. Even the manufacturing PMI for the euro area, one of the biggest causes of worry to European investors throughout 2018, seems to have bottomed out in September 2019 and is now back on a mild upward trajectory. Sentiment amongst European investors has also improved considerably. Take, for example, the Sentix economic index for the euro area — a gauge for investor confidence — which has sharply rebounded from its October 2019 low-point, climbing in January 2020 to its highest level since November 2018.
The key question is, of course, whether Europe has genuinely turned the corner or not. I’d argue that it is way too early to give the all-clear signal. First of all, despite the recent green shoots, economic growth in Europe remains anaemic and fragile. In fact, Q4 2019 marks with only 0.1% real GDP growth the weakest quarter in the euro area since Q1 2013. The economies of France (-0.1%) and Italy (-0.3%) outright contracted. In addition, recession risks around Germany have resurfaced with a vengeance. On a year-on-year basis, German industrial production dropped by 6.8% in December 2019, the strongest decline since the global financial crisis. So, things may well get worse before they get better in Europe.
Furthermore, there are several material tail risks lingering in the background that could further darken the outlook for the euro area.
We all know what happened next in 2018. Trade wars suddenly escalated, anti-establishment parties Lega and 5 Stars chalked up large gains in the Italian election in March 2018 and global economic data took a nosedive. As a result, investor sentiment soured and markets rapidly entered a prolonged risk-off phase causing risk assets across the board to produce deeply negative annual returns. I am not suggesting that history has to repeat itself. But I can’t help feeling that markets have again gotten ahead of themselves and complacency is reigning supreme. Sure, there is ample support from central banks, from the ECB in particular, providing favourable technicals and thus propping up asset prices. But just as a reminder, the ECB was buying assets to the tune of €30 billion a month from January to September 2018 — 50% more than at the moment — and markets still sold off in a meaningful manner. I therefore believe a rather cautious stance towards European risk assets is warranted. Reducing market risk exposure and trading up in credit quality seem prudent measures to me at this point.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.