The euro zone’s recovery, it seems, has been postponed by three to six months.
The region’s economy recorded zero growth in the second quarter, and recent surveys and hard data have diverged. While some surveys suggest a brighter outlook for economic activity, actual GDP, industrial production, construction and retail sales indicate the recovery has lost traction. We believe the euro zone paused for breath in the second quarter in what is likely to be the early stages of an uneven recovery.
We believe the region will continue to emerge from recession and is on track to achieve growth this year. There are three main reasons we expect activity to rebound in the second half. Firstly, the impact of the European Central Bank’s stimulus measures, namely: lower rates, targeted longer-term refinancing operations (TLTROs), asset-backed securities (ABS) and covered bonds purchase programmes; alongside the completed recapitalisation of the region’s banking system. Secondly, we have seen a recent weakening of the euro and this trend may continue. Thirdly, an increasingly supportive global environment.
Notably, peripheral countries that have implemented structural reforms performed well in the second quarter. Both Spain and Portugal expanded by 0.6 per cent quarter on quarter, and their prospects look particularly upbeat. Ireland’s economy has experienced a significant rebound of 2.7 per cent quarter on quarter growth.
The ECB has embarked, under Mario Draghi’s leadership, in a long-term project of expanding Europe’s capital markets and stimulate lending to small businesses in the process. An important development this summer has been the measures announced by the ECB in its credit-easing efforts.
The ECB announced it is ready to buy risky credit assets (ABS) to repair the transmission channel of credit. Notably, this is different from quantitative easing (which would involve broad-based asset purchases, potentially also government bonds). TLTROs and asset purchases programmes are credit easing measures which should work in the short and medium term to counteract falling inflation in the euro zone and allow banks to help them deleverage.
Harmonisation of the securitisation market and risk provisionings across Europe are longer-term projects which the ECB is working on to improve the region’s capital markets. Mr Draghi’s continued action plan is aimed at helping the banks to clean up their balance sheet while being able to lend enough to SMEs so that domestic consumption can resume.
The ECB’s success is conditional upon the governments in the region implementing the structural reforms needed to improve the competitiveness of their own economies. Most importantly, the Draghi “put” still stands for investors. After the stress tests and the two TLTROs pending until year- end, we will have a clearer picture of how much capital banks still need to raise and how long it will take until they actually start lending out capital to SMEs.
Europe continues to represent a compelling investment opportunity despite a backdrop of low absolute economic growth. This is because valuations remain attractive and, most importantly, companies in Europe remain exposed to an acceleration in growth globally led by both the US and China. As the deleveraging process continues in Europe, we believe quality as a style should reassert. Furthermore, in a low growth environment, companies with a high-quality focus should benefit.
Cesar Perez is the chief investment strategist for EMEA at JP Morgan Private Bank
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