15/05/06
Talking Point - Europe
Why is there such a divergence of views about Europe? On the one hand many political commentators and economists are generally downbeat about the region, while conversely most investors are rather positive. Which group is right?
People love to take pot shots at 'Europe'. A recent headline in The Business blared 'Euro zone heading for collapse without political union'. Recently in Financial News, Chris Huhne MEP discussed the political problems facing France, Germany and Italy. It is worth reminding readers of his criticism: that France, Germany and Italy have not taken advantage of monetary union, the region still suffered from a marked rise in economic nationalism, and the resulting 'sluggish heart to the region is a drag on the world economy'.
After such critiques, the question must be asked why any investor would wish to put hard earned cash into European stocks? Yet, fund flows into European equities have reached their highest levels since 2000, a rational response to the sharp improvement in corporate profitability to decade highs. Many commentators wrongly assume that European earnings growth will be low bearing in mind the muted state of the EMU economies. However, companies like ABB, Schneider and Siemens should be seen as geared plays on the global growth cycle, which the IMF has estimated was the strongest in the past two years since the early 1970s. Exports from Eurozone countries were up 13%pa in the spring. Secondly, the improving international environment is slowly feeding into domestic performance. The engine is Germany, where industrial production was last reported growing over 6%pa, but demand is feeding through the Eurozone, for example housing starts in France have been growing between 10-20%pa. European business confidence is now at 6 year highs and is currently in line with output growing 4% annualised, well in excess of the UK.
Is politics important? Yes, when it becomes a major hindrance on markets. Uncertainty about the ability of the new Prodi government to last long in office, and press through with necessary reforms, is clearly a factor in the relative under-performance of the Italian stock market year to date. A key issue for investors is whether governments actively stand in the way of corporate restructuring. Governments may wish to protect some sectors for political reasons, but 'Watch what they do, not what they say'. M&A activity across Europe has reached its highest levels since 2000. Transport would currently be a prime example, with ABB in the UK, ADP in France, Abertis in Spain and Autostrade in Spain all in discussions. In any case, Europe is not alone in seeing a marked rise in economic nationalism. The Dubai World Ports saga brought home to global investors the importance of 'economic security' to the US.
In particular, governments cannot stand in the way of the most important development for European financial markets: the integration of Eastern Europe. This is enabling a restructuring of the costs base of many European companies, whether through large-scale immigration into say the UK and Ireland, or considerable investment into the new member states by companies in Austria, Germany and Scandinavia seeking new suppliers and new markets.
A recent ECB study compared structural reforms across the OECD and concluded that Eurozone countries had typically undertaken more comprehensive reforms than elsewhere between 1994-2004 – largely because of the greater need for reforms! At the corporate level, a considerable amount of restructuring is underway, enabling companies to benefit from the improvement in global demand. Most European equity markets are responding, up some 75% in the past three years. Commentators like Chris Huhne are quite correct in their observations about pressures on politicians, and it is to be hoped that governments will take the opportunity of this current economic improvement to press ahead with further reforms. If not, while politicians may throw some grit in the wheels, they cannot stand in the way of the trends towards globalisation which investors are rewarding and benefiting from.
Andrew Milligan, Head of Global Strategy at Standard Life Investments
First published in Financial News on 15 May 2006
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