International Horizons – Europe in 2015

European economies continue to lag into the close of the year

The year of 2014 was characterised by a reawakening sense among investors that another crisis could be building.

Despite the economic under-performance and geopolitical risks which have emerged, increasing expectations that the ECB will eventually embark upon its own program of outright quantitative easing have underpinned continental equity markets.

In terms of growth, Europe suffered multiple setbacks at both the core as well as on the periphery during 2014. This was reflected in persistent downgrades to both French and German GDP forecasts while the Italian economy also deteriorated further on the periphery.  

On a more positive note, Spain was one of the strongest performers among Europe’s larger economies in 2014, although formerly one of the troubled periphery “bailout club” nations. The southern European nation is also forecast to remain among the strongest performers during 2015. (Goldman Sachs @1.6%, Commerzbank @ 2.3%).

Looking to the immediate future and the month ahead, all eyes are fixed firmly upon the January flash inflation estimate and the ECB meeting toward the close of the month.

Since the turn of the year, the probability that the ECB moves to combat dis inflationary and deflationary pressures this in Jan, instead of later, has increased. This is mostly due to last week’s December CPI figures, which showed inflation falling below zero and into deflation territory for the first time.

Since then, market expectations for an all out asset program from the ECB have continued to build, with many analysts now anticipating a move to purchase both corporate and sovereign bonds at the end of the month.

It is interesting to note that Bloomberg news reported late last week, that the ECB had been modelling various bond purchases programs, some of which include the debt of peripheral nations such as Greece and Italy, while other models built by the bank are thought to have excluded such bonds.

This report increases the risk of market disappointment later this month, in our view. With German and  French yields already close to record lows there is a widespread sense of valid scepticism over exactly what a bond purchase program could actually do for these economies.

Therefore, if the ECB were to announce a program which excludes peripheral nations, who have a greater need for assistance, then the whole idea could be met with scepticism from the market, adding fuel to the fire of far left and far right parties as well as leaving individual investors disappointed.

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The year ahead in Europe – 2015 Outlook

In terms of the full year outlook, we are reducing our expectations for European equities and are updating our analysis and price targets for relevant companies within our coverage universe in order to reflect this.

Whereas before we had hoped for a moderate recovery to generate a return to earnings growth for European corporates; we now believe that this is less likely to happen. Therefore, we anticipate that benchmark returns in most parts of the continent will be uninspiring at best.

On the contrary we see earnings growth on the continent remaining fractured, with some companies benefiting from a cheaper euro and lower oil prices, while other more domestic focused companies are likely to continue to struggle. This appears to be particularly likely in France, Germany and Italy.

In addition to this we are concerned about the impact that political risk may have on markets, most notably in Greece, France, Italy and Spain. We also note that the UK is a further bastion of muddy water in this regard.

Such concerns are not new to the UK and European investor’s horizon as a slow but sure shift to far right politics has been under-way for some time in the above referenced places.

However, with national elections now due to be held in three of the most euro-sceptic countries, 2015 appears to be the year that will bring forth a day of reckoning for the both the currency union as well as the political union.

The obvious concern among investors is that if just one euro-sceptic party is able to gain power and begin a push to exit the union, a blueprint will have been set for others to follow suit at a later date; which would then lead to a prolonged period of even greater uncertainty for the continent.

This holds negative connotations for equity markets as, with elections at the January, May and December points; bouts of uncertainty are likely to be a frequent occurrence during the coming year.

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The takeaway

Looking ahead, and on the contrary to much of the above, we see potential for growth to weather the storm in the euro area during the year ahead. This is given the low base of GDP, at 0.8%, as well as the additional boost that many nations will receive from a lower euro and lower oil prices.

However, on balance, we are less optimistic in relation to European equities. This is mostly as a result of risks to investor sentiment and the likelihood of uninspiring earnings growth across broad swathes of continental indices.

In relation to quantitative easing, we are in line with consensus in that we do expect the ECB to act in 2015 in order to fend off accusations that it has done too little to fulfil its obligations under its mandate.

In light of the December slide in inflation to below the zero level, we revise forward our expectation for when the bank is likely to act, from March to January this year.

While this is likely to have a moderately positive impact upon markets we do not believe the effects will be equivalent to those seen in 2013 after the FOMC announced its own record asset purchase program.

Therefore, our central view is that continental economies and corporates are likely to receive a greater boost from lower oil prices and a weaker euro than from the direct impact of ECB QE upon interest rates.

EU Indices 2014

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DAX 2014 / Daily Intervals

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CAC 40 2014 / Daily Intervals

CAC40 2014

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IBEX 35 2014 / Daily Intervals

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