Schroders Quickview: Greece crisis to restrain European equities, but valuations should provide buffer
Volatility in markets is likely to continue for an extended period until the ramifications of a potential Greek exit from the euro are fully understood. QE and current valuations could provide some downside protection for European equities.
29 June 2015
Grexit to test eurozone recovery
Whilst an exit is not a certainty at this point, the probability has significantly increased - particularly given next weekend’s critical referendum.
The negative market reaction today has been modest and partially reverses the gains we saw last week.
As we have said repeatedly, the consequences of a Greek default and the imposition of capital controls will have a dramatic effect on Greece but a limited economic bearing on the wider eurozone.
This is a generally accepted view, but our concern from here is the medium-term impact on the broadening economic recovery taking place in Europe right now.
European equities likely to stall
We will not know for some time how business confidence may be influenced by the uncertainty and fears of possible contagion to other eurozone countries, particularly the periphery.
Much will depend on unknowable Greek factors such as potential social unrest and associated media coverage, Russian involvement, the depth of the recession and so on.
It is difficult at this point to envisage European equities making much headway in this scenario.
Even if we are right about the wider limited economic impact, it may take several months for the market to accept clarity around the sustainability of the eurozone recovery.
European equity investors should remember the following crucial points:
- The European Central Bank (ECB), having capped the Greek ELA (emergency liquidity assistance), has said it is scrutinising markets to ensure they are able to deal with areas of instability.
- The “Draghi put” is alive and kicking; the quantitative easing (QE) programme will ensure bond market contagion is very limited.
- The QE programme itself is, however, only in place for a certain period of time, which is why in our view the ECB and the European governments need as far as possible to resolve the Greek crisis this year.
- While expectations of a recovery have been factored into equity valuations to some extent, the potential for margin expansion across many European corporates remains.
- The current 2015 forward price-to-earnings multiple of 16x falls to 12x if we assume aggregate European margins get back to 2007 levels, which are still well below those being reported in the US.
In summary, the Greek uncertainty and possible contagion of confidence is likely to cause continued volatility and constrain the upside for European equities for a period of time.
However we also believe there is reasonable downside protection given the ECB QE programme and current European equity market valuations.
- Europe ex UK
- Rory Bateman
- Quantitative Easing
- Monetary Policy
Important Information: The views and opinions contained herein are those of Schroders’ Investment team, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. UK: Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA, is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. Further information about Schroders can be found at www.schroders.com US: Schroder Investment Management North America Inc. is an indirect wholly owned subsidiary of Schroders plc, a SEC registered investment adviser and is registered in Canada in the capacity of Portfolio Manager with the Securities Commission in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec and Saskatchewan providing asset management products and services to clients in Canada. 875 Third Avenue, New York, NY, 10022, (212) 641-3800. www.schroders.com/us