Takeaways: The Eurozone, UK and ‘emerging markets’ have something in common: the sharp juxtaposition of optimism and concern. In varying degrees; but the contrast between opportunity and threat highlights the complicated patchwork of growth and risk companies are navigating. Was it ever thus? Risk isn’t new, but perhaps there is more flying in from ‘leftfield’ and there are certainly greater forays into market unknowns – such as the great Fed unwind. Markets remain highly accommodative, but they still have the potential to twitch. Opportunities abound, but selectivity is still vital with smart divestment playing its part. In these markets, companies can also expect greater interest in how they perceive the future. Time to take a fresh look at countries, markets and corporate portfolios…
Eurozone 5:2….more feast than fast
It seems that almost overnight the Eurozone went from being a curate’s egg to a global capital magnet. This week has brought a more typical mix of chastening and optimistic news; but with the balance now tipped firmly towards the positive. More feast than fast…
1. Policy Support
The ‘whatever it takes’ OMT Programme provided stability. Now, in adopting QE, the ECB is taking the next step to try and boost growth and inflation. Whatever you think about the actual economic benefits of QE, it’s hard to fault the ECB’s commitment to reviving the region’s economy.
2. Cheap capital
There is growing debate over whether there will be enough sovereign bonds for the ECB to actually buy – a problem that gets more ‘interesting’ as yields fall. Either way, we have an exceptionally tight sovereign market with demand spilling over into corporate debt. We talked last week about how US companies are increasingly looking to Europe for capital – spurred on by a euro falling closer to dollar parity. This appears to be extending to Chinese companies, as they issue $2.9bn worth of euro-denominated debt so far in 2015, close to the $3.3bn issued in all of 2014.3.
The improving outlook in place before QE is gathering pace. Our latest Eurozone forecast, released today, forecasts that GDP growth will accelerate in 2015, increasing from 0.9% in 2014 to 1.5% this year and to 1.8% in 2016. This week, the OECD said that Eurozone indicators were pointing towards a “positive change in growth momentum“. Services and manufacturing industry activity is at a seven month high, according to Markit. As a net importer, the Eurozone is well placed to benefit from cheaper oil and of course cheap Euros should boost exports. Every $0.2 move in the euro against the dollar is worth about 5% in operating profit to European corporates. Although, ultimately the impact may be limited. The ECB isn’t the only central bank engaging in ‘currency surrender’.
4. Rising Assets
Our chart shows what happened to US cyclically adjusted price-earnings ratios (CAPE) during QE – and the potential for the Eurozone. Falling bond yields will provide an obvious incentive for investors to shift over into equities. The opportunity hasn’t passed investors by: European acquisitions by a foreign suitor have reached $73.4 billion so far this year, the highest amount at this point since Thomson Reuters records began in the 1970s.
5. Investment potential
Theoretically, this all should lead to increasing investment – a key part of the recovery jigsaw. The US example provides the caveat here, since US buybacks increased by more than 40% between 2010 and 2013, eclipsing capex. European levels are unlikely to get close to that total. Borrowing heavily to fund buybacks isn’t as de rigueur or as easy here. However, the $8bn of European buybacks announced so far in 2015 signals serious intent. You can be sure that governments won’t take this quietly. Given the machinations and energy required to get QE off the ground, companies can expect short-shrift if the benefit goes to investors, rather than investment.
Public debt still sits at around 96% of GDP for the Eurozone overall, acting like a millstone around the region’s economic neck. Gathering additional economic momentum once the QE boost wanes (and oil prices pick up) will be tough. Our forecasts show Eurozone growth at just only 1.6% a year in 2017-19, held down by structural constraints
That Greek toothache has flared up again. Somehow both sides returned to a stand-off just two weeks after agreement. This is how it’s going to be. Although GREXIT would be devastating for Greece, the risk to the rest of the region’s banks and the future of Eurozone as a whole is small, according to S&P. However, even without an exit we’re mindful of the negative impact on the region as Greece moves from crisis to crisis, along with the potential for further political upheaval. Other peripheral nations have worked hard to reform, but more is required and – like Greece – patience is wearing thin. Youth unemployment remains at 41.2% in Italy, 33.6% Portugal and 50.9% Spain. QE may give breathing space – but is there the will to push harder?
The message we take from this is to look at Europe selectively and with fresh eyes. To think about capital allocation and company portfolios in the light of a new market environment. Acquisitions are certainly back on the agenda and companies looking to divest and reallocate capital can get ahead by preparing assets for sale as early as possible. EY’s latest divestment survey shows how high performers take the time to prepare well in advance of a sale, understand the potential pool of buyers and their needs, and communicate the value of the transaction to shareholders.
56 days…and counting…
The UK is, of course, doing rather well in economic terms. It’s the only other major economy, aside from the US, that could be said to be on the path to monetary tightening – albeit a circuitous one. There are niggles around areas like balance, deficit, productivity; but 2.9% annual growth provides pretty good platform.
However, a risky unknown looms now large on the horizon.
It’s a truism to say that markets and companies don’t like uncertainty, but they don’t. The upcoming General Election is causing concern, not only because the result is so uncertain, but because companies can expect significant changes in fundamental areas.The result has the potential to spark change in tax policy, in the constitution of the United Kingdom and in the UK’s relationship to Europe. Hence, the concerns of WPP’s CEO and investors, who – as the FT observes are “paying relatively high premiums to protect themselves against the threat of sterling tumbling in the immediate aftermath of May’s vote”.
Looking back to May 2010 for lessons, the UK economy is obviously in better shape and better able to withstand a period of uncertainty. Markets are less jittery. However, a drawn out hiatus in government will have a significant impact on companies serving the public sector, who already face further rounds of ‘austerity’. In the year following the last General Election, EY’s research shows that over thirty UK quoted companies issued profit warnings relating to cuts in public sector spending or disruption to contracts. Companies should be stronger now and more prepared; but it’s hard to be fully forearmed with an outcome this uncertain.
Who’s afraid of the big bad dollar?
The other big news this week is the ever strengthening dollar, pushing the euro closer to parity, pushing down on commodity prices, lowering the volume of ‘Yankee Bonds’ and crushing emerging market currencies…oh, but not entirely. The Indian rupee and the Philippine peso have just about appreciated against the US dollar this year. Not massively, but enough to stand out amongst sharp falls elsewhere.
The emerging market story is clearly mixed, with investors needing to take a fresh, differentiated look. Oil exporters are being hammered by a double-dollar whammy. Brazil is in its worst downturn since 1990. However, this leaves oil importers like India, the Philippines and Thailand reaping the benefit of low energy bills and low inflation. There is also some element of self-help aiding their revival. India was in the global market ‘dog house’ in 2013, but is now feeling the benefit of investor optimism and inflows as it sets out a programme of reform. The Philippines is profiting from a growing outsourcing sector.
That said, there is still fragility here and all will have a wary eye on China, whose recent growth numbers suggests it could struggle to reach even its lower targets. Countries also need to keep on the path to reform to keep investors onside. This last few months shows how quickly they can turn tail.