I’ve been arguing for most of the last 12 months that the Eurozone is the place to ‘be’ in asset allocation terms – along with emerging markets. All the breathless predictions about the end of the EU and a populist tsunami washing across the continent were always way off the mark in my view. The continent is largely powered by a bunch of fairly predictable factors not least FX rates, Chinese demand for expensive Eurozone industrial products and domestic consumer demand. China seems to be ticking along very nicely which helps the big German brands while the Euro has, until recently, shown signs of weakness against the dollar. Equally any trip to a Northern European city would have confirmed anecdotal evidence that those Eurozone consumers with a higher mix of citizens with blonde hair (!) are feeling confident right now.
This last observation received some backing last week from a note by European equity analysts at Morgan Stanley. In a mid summer note to investors, the team observed that Eurozone consumers have rarely felt so good. “ Five years after the depths of the Eurozone crisis in 2012 we now find that consumers across the region have rarely been as optimistic as they are today. The European Commission’s consumer confidence survey is at its highest level since 2001 and at a level that has only been exceeded 5% of the time since 1987. [see chart below]”.
source: Morgan Stanley
The weak Euro has, up to now, helped boost confidence in the Eurozone. Now that the currency is increasing in value against the dollar, what happens next to local consumer confidence? “In this context”, the analysts argue ”it is important to note that the main driver of the Euro-zone GDP rebound in this cycle has been domestic demand and not exports (in fact net trade has been a modest drag in for much of the last 18 months. Consequently, the economy should be fairly resilient to currency strength for now unless the Euro moved materially and quickly higher.” To stress test this assumption the bank’s analysts have spent “not inconsiderable time looking for a chart showing a link between a stronger Euro and absolute or relative weakness in economic activity such as PMI readings or exports. We have found no consistent link ….as a general rule of thumb we have always argued that FX is a much more important consideration when growth is weak than when it is strong”.
So, time to load up on Eurozone funds and equities? Not quite, because the MS analysts have a sting in the tail. The report notes that resurgent Eurozone confidence (especially when measured against UK consumer demand) is usually “a late cycle phenomenon and/or a cautionary sign for markets. Since 1987 the average 6m return for MSCI World has been 0.1% when Eurozone confidence was higher than in the UK versus 4.9% when UK consumers more optimistic.”
I would add my own caveat at this point – of a more long-term nature. I am of course delighted that the hordes of right/left-wing populists have been beaten back in the Netherlands and France. President Macron could be an enormous success – I hope he is. If he isn’t though and his reform programme crashes, we have a real problem. Every informed French voter I have talked to agrees on one point, regardless of which party they support.
If Macron fails, it’s game up for the current system. We’d see a hard right or hard left-wing president in office. It might be a Le Pen or Melenchon or maybe someone entirely new, like Macron, who is catapulted into the body politic. The economic consequences will be terrible to behold and might unravel the EU. In essence, Macron has just a few years to bind France ever closer into a tight fiscal union – with liberalized domestic markets. Even if he doesn’t succeed there’ll be chaos and carnage.