Nick Edwards of Guinness Asset Management
Europe’s run of poor manufacturing and trade data continued in June.
PMIs across Germany, France and Italy came in below expectations last week and German factory orders of -8.6% year-over-year caused concern that trade friction might spread to the domestic economy.
Eurozone government bond yields went further negative amid concerns over slowing growth, lower inflation expectations and overall ‘Japanification’ of Europe.
Bond proxies and quality growth responded favourably to lower discount rates and the potential for stimulus.
However, high asset prices and the prospect of deflation are uneasy bedfellows. It seems QE has reached its limits and this trade has gone as far as it can.
Where next, with government bond yields close to -0.5%? Why hang around in politically troubled Europe, where investors have been burned before?
Our contention is the forces of deflation are weaker than bond market prices portend. Service data has persistently surprised to the upside, while policy-driven inflation may take time to permeate a service-led economy.
Liquidity and lending data are robust, and wage inflation in Europe and the US is at five-year highs of near 3% year-over-year.
Why would central bankers start a new rate-cutting cycle with interest rates well below wage inflation?
Moreover, recent weakness stems from Trumpian trade policy, which can be changed at will.
Since the Global Financial Crisis, policymakers have had a choice between reflation or deflation and default. We do not think the overall policy response will change, but at this juncture a different prescription is required.
The European Commission’s leadership chaos produced a French, female and federalist trio, among whom Christine Lagarde seems a likely champion of Mario Draghi’s wish for individual governments to act on fiscal policy and of Macron’s call for capital markets union.
If, as we suspect, the route taken is via fiscal policy to reflation, the implication for markets is a pivot towards value over growth.
Europe’s rich history of competing city states and resultant world-class intellectual property often get forgotten amid the noise and growing pains of its politics.
Nick Edwards is co-manager of Guinness European Equity Income fund
• Opportunity to buy into value ahead of a shift to reflation
• A wide choice of companies characterised by high levels of self-determination
• Germany’s large trade surplus highlights high exposure to disrupted global trade
• Political decision-making impeded by wide array of interests among EU members