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Investment analysis: What’s next for the ‘triple zero’ eurozone economy?

The eurozone is breathing easier these days thanks to the European Central Bank’s quantitative easing programme.

The central bank raised this year’s Eurozone growth forecast to 1.5 per cent up from 1 per cent previously. Eurozone consumer prices fell by 0.1 per cent in March 2015 from a year earlier, suggesting that fears of continued deflation might end.

Despite QE in Europe devaluing the euro at the same time, increased investment flows into Eurozone markets have buoyed equity markets, as they did for the US and UK when they started their QE programmes in 2011.

The ECB stimulus has pushed European equities up 16.8 per cent in the first quarter of 2015 and up 30 per cent since mid-October 2014, says S&P Dow Jones Indices senior director Tim Edwards.

Eurozone countries have also delivered almost double the share price returns of non-euro countries in the first quarter of 2015, according to the Euromoney Indices. 

BlackRock chief investment strategist Russ Koesterich says investors are adopting a “glass half-full” approach to European equities as the asset is still “reasonably priced” compared to the “increasingly stretched US stockmarket”.

He adds: “The divergence in monetary policy, which we expect to continue, has resulted in a big boost to European exporters, particularly automakers and industrial companies.”

“[This is] an important consideration given that 50 per cent of revenue for European large-cap companies comes from outside the eurozone.”

Schroders European Alpha and Alpha Plus fund manager James Sym is as positive on Europe in 2015 as he was in the past six or seven years. “We tell our clients to still invest in European equities especially compared to other asset classes.”

He claims 2015 is going to be the first year in six where European earnings will grow “significantly higher than the US”.

That has massive implications for everybody who is overweight US equities, which is most people, he adds. But for those who want to access the European recovery there are still cheap sectors with earning momentum.

The financials in Sym’s portfolio, especially Italian and Spanish banks, are the cheapest sector because these companies “are starting from a very low level of profitability,” he says. 

European banks underperformed before QE started, says Premier Asset Management fund manager Jake Robbins, who manages the Global Alpha Growth fund. “You’ll now see a rotation from quality into value if the economic growth comes in Europe – and banks will benefit the most.

“The US market has a lot of oil names and global businesses are downgrading because of the strong dollar, whereas in Europe the scope for earnings to grow is a little bit higher.”

However, he thinks the US will grow faster than Europe as it is a “much more dynamic economy” and more heavily exposed to sectors such as technology and healthcare, compared to a more old-fashioned Europe which is heavily regulated.

“Until [in Europe] they free up their economy and start developing faster global industries, the region is always going to lag a bit over the long term,” Robbins says. 

Hermes Investment Management manager Martin Todd, co-manager of Hermes Sourcecap European Alpha fund, believes that in this ‘triple-zero’ economy of the eurozone – zero growth, zero rates and zero inflation – growth is scarce and companies able to deliver it should command a “much higher premium”.

“In this environment, we prefer structural growth plays and those companies taking destiny into their own hands through restructuring,” he says.

Old Mutual Global Investors fund manager Kevin Lilley, who runs the Old Mutual European Equity fund, says: We should get a shift towards more value type of stocks in the market again as growth continues to pick up.”

State Street Global Advisors head of exchange traded funds sales strategy for EMEA Antoine Lesne says the ECB bond purchasing programme has started but credit spreads have widened.

This hasn’t stemmed exchange traded product flows though, with $8.3bn (£5.6bn) invested in 10 weeks ”making the euro fixed income universe the strongest this year in terms of asset gathering, after European equities,” he says.

The high-yield ETF market has proved to be “a venue of choice” for both tactical and long-term investors as ETFs allow investors to buy positions rapidly at low cost, Lesne adds.

While in the short term QE may have benefits, the longer term outlook is not as rosy, says Robbins.

“In the short term we think QE will continue to support assets and equities from an income point of view as you can get a decent yield. While QE is of enough support in the short term, the dangers could come in the second half of the year,” he warns.

“A year ago the European [purchasing managers index] was higher than now but that didn’t necessarily resolve in strong economic growth in the second half of last year,” Robbins adds.“

Sym is convinced that for the recovery in Europe to become self sustaining companies need to start “spending more” in the coming quarters, while Koesterich warns that the Eurozone is threatened by “structural challenges” that impede long-term growth.

“A host of issues have yet to be confronted, let alone solved: structural impediments to growth, dangerously low inflation and rising populism following five years of little growth and painful austerity,” Koesterich says.

However, reforms in some countries will lead to growth, says Sym. “Because of the crisis, Merkel has forced peripheral countries to structural reforms.” As a result, he thinks Spain will grow more than 3 per cent this year.

“In three to five years Spain, Italy and Ireland will be doing what Germany has done in 2000. Germany has started to become less competitive now.”

The large elephant in the room for the Europe story is the ongoing trauma in Greece, and the continued fears of a Grexit.

It is increasingly likely Greece will leave the Eurozone, says Sym, but he agrees with his peers that a Grexit is less of a worry now than it was in 2012.

“It might be better for everyone if Greece left because even if the ultimate cost is higher of leaving the Euro it might be better to take the adjustment in one go.” 

Lilley agrees with Sym that Europe is quite “well insulated” against the Greek crisis. “We’ll get a market correction if any bad scenarios occur but that’ll be a minor one,” he says. “Europe is a collection of countries and we’re always going to see some tensions and we have to just accept that.”

However, the involvement of politics in Europe may change its course. “It still remains to be seen whether Europe’s long-term future will be driven by political will or economic realities,” Koesterich says. 

“The ECB has allowed politicians not to reform. It is giving them breathing space so the euro has collapsed and helped companies’ profits,” Robbins says. ”Politicians might waste this time and we could be in the same position we were a year or two ago.” 

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