investment viewpoints

Europe – the tide is turning

July 6, 2020

Didier Rabattu

CIO, Sustainability Equities

Pascal Menges

CLIC Equities, CIO Office

We believe the conditions are now right to drive investors back to Europe after a lost decade.

The actions taken by authorities in response to the pandemic are setting the stage for a new period of European economic strength and stability. In addition to strengthening the economic health of the Eurozone, these plans would create a wealth of investment opportunities. It is our view that there are now five key arguments in favour of Europe.

Firstly, there are the unprecedented fiscal and monetary measures that have been enacted. The European Central Bank (ECB) has now introduced a series of extraordinary measures designed to support the liquidity and financial health of the Eurozone economy, such as the Pandemic Emergency Purchase Programme (PEPP). This is hardly the first time the ECB has intervened in markets but these latest proposals are unprecedented both in terms of speed and scale.

There is also the fact that the European Commission remains engaged in a long-term sustainability drive with a stated aim to ultimately make the European Union carbon neutral by 2050, leading to an ambitious investment plan that could ultimately reach EUR 7 trillion by 2050. The European Green Deal Investment Plan, which is the investment pillar of the ambitious Green Deal industrial strategy, and is intended to mobilise at least EUR1 trillion in sustainable investments over the next seven to 10 years.

Thirdly, France and Germany recently announced plans to join forces in order to propose a COVID-19 economic recovery fund, with a funding mechanism which paves the way for potential increased fiscal integration and would enhance the credibility of Europe as monetary bloc. Transfers will be based on need, rather than contributions, to the EU budget and in forms of grants rather than loans which put forward clearly the concept of “solidarity.”

We can also see evidence of the banking sector being freed up to form part of the solution to the crisis. European banks are being “un-constrained” as they are being freed to use their capital buffers and they will benefit from lower funding costs.

Finally, it is now clear that Europe has been more effective in combatting the pandemic than other countries. This discrepancy will likely be reflected in the strength of the economic re-start. These dynamics creates much more volatile economic conditions in the US, for example, when compared to Europe where the upturn in the economic cycle could therefore be more pronounced.

This is very relevant from a market perspective. European equities are the most exposed to a cyclical recovery. We estimate that 30% of the European Equities are in sectors the most exposed to a cyclical recovery. This exposure is even greater when looking at the smaller companies (MSCI Europe ex-UK Small index) with close to 37%. In addition these sectors are also important beneficiaries of the EU recovery measures.

Global investors require still a much higher risk premium to invest in European large cap and European small cap than for the US counterparts. These higher risk premiums have not aligned with the US since the European sovereign crisis. This is particularly true for European small cap.

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