Europe Now Leading the Pack

22 May 2017

The eurozone is currently achieving the best economic figures. The US is no longer keeping pace with the Europeans, despite – or possible because of – Donald Trump’s plans. We are taking a neutral position in equities. Partly because of the chance of rising interest rates, we are underweight in bonds.


Eurozone Outpaces US in Economic Growth
First-quarter growth figures for the most important economic regions were released over the last few weeks. Figures for the US were disappointing, with quarterly growth of 0.7 %, annualised. It is possible that this provisional figure will be adjusted upwards in the near future, as has consistently been the case with the first-quarter figures in recent years. For the first time in a long time, investments were the most important contributor to American growth, particularly due to a revival of new exploration in natural gas and oil fields. Other components of economic growth disappointed. Consumers reined in spending. Even in April, there was no upswing in automobile sales. The eurozone outperformed the US, with growth of over 2 % annualised. All growth components contributed to this performance.

Still No Noticeable Rise in Inflation Globally
Inflation figures around the world remained in line with expectations during recent months. Inflation in the eurozone fluctuated heavily due to seasonal factors, but still showed underlying stability. Recently, eurozone countries with the lowest unemployment have witnessed the strongest rise in labour costs, yet this has not had a discernible effect on the general price level.

Investment Categories

Macron’s Win Pushes Spreads for Peripheral Eurozone’s Government Bonds
The return on bonds, expressed in euros, amounted to 0.5 % in April, according to the iBoxx Overall Index. As such, the decrease for the year so far halved to negative 0.5 %. The interest rate on ten-year German government bonds dropped by one basis point to 0.32 %. In peripheral eurozone countries, interest rates dropped sharply, particularly after Emmanuel Macron’s victory in the first round of the French presidential elections. The French ten-year interest rate dropped by 13 basis points. The IMF and Europe sent positive signals with regard to aid for Greece, causing the Greek ten-year interest rate to drop from 6.99 % to 6.34 %. The ECB’s monetary policy remained unchanged, but the central bank reported a reduction in downward risk for economic activity. Spreads for corporate bonds decreased: the CDS iTraxx Overall dropped from 74 to 67 basis points.

Confidence in Europe Spurs Equities
Measured in local currencies, the equity market continued its upswing in April, with the MSCI World Index gaining 1 %, resulting in a positive gain of 6 % for the year so far. However, measured in euro, equities dropped by 3 % in April. The eurozone had the strongest currency as well as the most strongly rising equity market. The MSCI Equity Index for the eurozone rose 2.3 %. In terms of sectors, the energy sector started lagging behind again worldwide, with a loss of 4.1 % in April. Meanwhile, the IT sector continued to perform well. The ‘FANG’ (Facebook, Apple, Netflix and Google) equities have already achieved an average price gain of 24 % this year. In contrast to these success stories is the downfall of department stores. The S&P 1500 Index for this category of businesses dropped this year by 17 %. The increasing importance of online sales is also reflected in price development for various groups of real-estate funds in the US. Funds focussing on retail property have seen an average loss of 9 % this year, while funds for industrial real estate (including distribution centres for online sales) have experienced average gains of 4 %.

British Pound Continues to Recover
The currency markets experienced some movement. The euro appreciated in value due to the results of the first round of the French presidential elections. Only the British pound was stronger than the euro in April. This was due in part to the announcement that the UK will hold elections in June, which will strengthen the British May government.

Economic Forecasts

European Figures Continue to Surprise
Europe’s current economic figures remain surprising and, as expected, the eurozone has started to catch up. At the same time, confidence in Europe’s political situation has risen in the aftermath of important elections. Elsewhere, developments are less favourable. For some time now, American consumers have been reluctant to spend. The initial enthusiasm that greeted the Trump administration has become more subdued. Households who consume the majority of their income are probably worse off under Trump’s healthcare and tax plans. In China, the government seems to be easing off the gas pedal on stimulus at the moment. Worldwide, stimulating monetary policy will make more room for fiscal stimulus. The same applies in the eurozone, possibly following the German elections this fall. Overall, we do not expect for economic policy to strongly stimulate economic activity. We expect underlying inflation to continue to rise very gently in the coming quarters.

Asset Allocation

Strongest Profit Growth in Europe
Most companies have published their profit figures for the first quarter of 2017. Profit growth clearly accelerated worldwide, with growth per equity reaching 10 % in the US and even more than 20 % in Europe. These figures can largely be attributed to macroeconomic tendencies. In the first place, year-on-year growth in worldwide economic activity accelerated in recent quarters, and inflation also increased. This caused the gross margin (revenue minus costs) to rise. Operational margins historically show a strong correlation with economic growth. The margins rise whenever growth speeds up, which has been the case in recent quarters. Additionally, net interest expenses have not yet increased around the world, and taxes have decreased, partly because countries are competing to provide the lowest corporate tax rates. We expect higher profit growth in Europe than in the US in the quarters ahead as well. In Europe, economic activity is showing stronger increases. Operational margins also offer greater potential for improvement here.

Underweight on Bonds due to Risk of Rising Interest Rates
In our mixed portfolios, we are underweight on bonds compared to cash. The interest rate is still very low, which makes the expected return on bonds unattractive to us. Additionally, inflation will slowly return, which will cause more central banks to raise interest rates and buy up, or even sell, fewer bonds. Following the recent period of good economic news, the risk of economic disappointments is growing. We see the eurozone as the region with the most robust recovery and the best chances for growth. Globally, we are taking a neutral position on equities in our mixed portfolios.