Outlook 2015: Business cycle (European equities)
Quantitative easing (QE) remains a possibility in Europe but Germany also needs to take steps to stimulate demand. In sector terms, banks and telecoms offer interesting opportunities.
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The European economy is facing some weakness as we head into 2015. Recent macroeconomic data has indicated a slowdown across the eurozone and notably this is now extending to Germany, usually the region's economic powerhouse. The third quarter GDP figures confirmed that recession has been avoided but the environment remains one of low growth.
We view the current situation as a good time to buy European equities and highlight the opportunity potentially on offer if the ECB does embark on a full-blown programme of QE.
QE remains on the agenda
The European Central Bank (ECB) has taken measures to ease monetary policy. The steps taken recently - including the introduction of a negative deposit rate and the programme to buy asset backed securities - should provide a supportive environment for eurozone equities. The measures have resulted in a weaker euro, which could lead to positive earnings momentum in 2015. There may well be more unconventional measures yet to come in the form of QE, and certainly Mario Draghi has reinforced the impression that the ECB’s balance sheet will be expanded by €1 trillion.
Another important step taken by the ECB was the Asset Quality Review of the region's banks. This showed that the banking system in the eurozone is now stabilised. With pressure on banks' balance sheets easing, they can return their focus to the core activity of lending in order to support much-needed business investment and economic growth. Questions remain over whether the demand is there but the latest survey from the ECB indicates that overall demand for credit is picking up slowly.
Germany to stimulate demand in Europe?
We would also highlight that the recent weakness witnessed in the German economy has potentially positive implications in terms of eventually stimulating demand within the eurozone. In our view, Germany's recent weakness has been due partly to the tensions with Russia, which calls into question the sustainability of German industrialists relying on Eastern Europe for their growth. It has also partly been due to the economic slowdown in China. Germany therefore needs to try to rebalance its economy and stimulate demand both from within its own borders and from within the eurozone. Certainly, this will require a change of attitude and may take some time. Also, the German government needs to invest, particularly in domestic infrastructure, where it has underinvested for many years.
Banks and telecoms offer opportunities
In terms of areas of the market that could do well in the coming year we have already touched on the banking sector. The ECB is incentivising banks to lend via the Targeted Long-Term Repo Operations (TLTROs). With banks able to borrow from the ECB at ultra-low rates, the margins they can make on new loans will have a substantial positive impact on profits. The recovery of the real estate market in some parts of Europe is another factor that could help support the banks.
The telecoms sector also looks attractive to us. Regulatory pressures have hurt returns amid the clampdown on roaming charges and mobile termination rates. That tough environment is now changing as regulators have turned their attention towards encouraging operators to invest, particularly in broadband. Some Scandinavian countries have already made this investment and operators have seen their revenues rise as a result. There is scope for this trend to be repeated across the rest of Europe.
Meanwhile, the precipitous fall in the oil price should provide a boost for corporate earnings in general as input costs come down. It is also good news for consumers and should increase spending power over the all-important Christmas period. We therefore see opportunities within the consumer cyclicals area of the market, such as leisure and tourism.
Good opportunity to buy European equities
Overall we view the current situation as a good time to buy European equities. We would highlight the opportunity potentially on offer if the ECB does embark on a full-blown programme of QE, as many think it will. Government bond prices are currently high in Europe and yields are correspondingly ultra-low. QE would offer existing bond investors a good opportunity to sell their bonds to the central bank and use the proceeds to invest in the equity market.