Time away gives you some perspective, especially when you are outside of North America. Coming back from Europe this week it is hard not to see why investors have warmed to that region this past year. Adjustment to the euro turmoil that existed 3-5 years ago is coming along nicely and as much as the terror element captures headlines, individuals appear to be also adjusting to a new normal. The question is how long can the good news last?
Let’s first take a step back and look at Europe’s performance since the start of the year. True, the 5% gain in the benchmark Euro Stoxx index is less than half the move seen in the Dow and about a third of the rise in the Nasdaq. Adjusted for currency, however, and we get a different story as the index has climbed more than 17% in US$ terms. That is because the so-called ‘Trump rally’ fell on deaf ears in the foreign exchange market, while global flows from an overvalued US market into Europe sent the euro up from around US$1.04 at the start of the year to USS$1.19 this month.
The advance in the euro resembles what we have seen in the Loonie this year and may look a little perplexing given that it is the US central bank that has done almost all of the heavy lifting in terms of rate increases. At current levels the euro has returned to where it traded in January 2015, but this is still a far cry of where it was after the global financial crisis in 2009 (US$1.50). Given the reduced probability of a near-term deliverable on US fiscal stimulus, many analysts believe that the euro can continue to recover lost ground (It has now retraced just over a quarter of the 2009-2017 correction). Strengthening economic fundamentals have contributed to the early phase of the rally as seen in both GDP growth and continued declines in unemployment.
At 9.1% the unemployment rate for the eurozone is at the lowest level since February 2009 and down three percentage points from the peak in 2013. That is less than half of the improvement seen in the US, however, structural rigidities that have plagued the region are beginning to melt.
With the economy strengthening, the market has turned its attention to when the European Central Bank will start to back away from its aggressively easy monetary stance and negative official interest rate target. Recall, the ECB was late to the game in terms of quantitative easing (bond purchases) and started its program of 60 billion euros per month only in March 2015. Some officials within the ECB would like these purchases to be curtailed by 2018, but ECB President Draghi is going to be reluctant to act too soon. By the time this newsletter goes out, he will be making his address to the Jackson Hole symposium and most expect him to be vague with respect to future policy prescriptions, especially with the currency where it is. Continued support will also be welcome for peripheral Europe and there again it was interesting to see how the region has adapted.
Five years ago, when Mr. Draghi said he would do anything to protect the euro in the face of the Greek crisis, there was a legitimate concern over the economic viability of this country and the euro system. Greece is still in an economic quagmire, but prospects have improved. The country has just run a primary budget surplus of 3 billion euros and parts of the nation are exhibiting higher inflation than the eurozone as a whole. One could argue that islands like Santorini never saw a crisis to begin with.
This has attracted foreign flows and for the past year, Greece’s bond market has outperformed every nation in Europe. Where the eurozone’s benchmark bond index has been flat since the start of the year, Greece’s is up more than 15%. Stocks in Greece have also outperformed this year with the Athens benchmark ASE index up close to 30% or 45% in US dollar terms. Much of this is simply a bounce from horrendously low levels and there are sceptics who see this as unsustainable. Then again, as long as the political mess in Washington persists the eurozone, both core and periphery, may still offer value to investors. This is why we have maintained exposure, while cutting in the US.
Canada: Producer prices, current account, Q2 GDP
US: S&P CoreLogic CS home prices, consumer confidence, ADP payrolls, Q2 GDP (revision), Chicago PMI, non-farm payrolls, ISM manufacturing, vehicle sales
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