Jacob Mitchell (pictured) is CIO and portfolio manager at Antipodes Partners.
As a monetary union with structurally different economies, the eurozone has often been described as an economic impossibility. The dilemma of having a monetary union without a fiscal, banking or political union has been horribly exposed in recent years.
Indeed, new French President Emmanuel Macron believes the EU and the eurozone will not survive long without further integration. However, what is the way forward?
Investors have become accustomed to believe that either the EU will permanently remain an inflexible union or disintegrate. However, there is a middle ground between what is good for an individual nation and also the region as a whole, where the necessary flexibility is provided by European institutions and common public goods.
Europe needs tighter integration in certain areas, including greater security and military cooperation. Economically, it is difficult to retain a common currency and a one-size-fits-all monetary policy, without allowing regional economies to rebalance via fiscal policy and a banking union to contain deposit outflows in a crisis.
Greece is a great example of this dysfunction, its banks having lost plenty of deposits and no plan for growth – despite the ECB’s emergency liquidity assistance. Meanwhile, Greece continues to focus on exceeding budget surplus targets even though the economy is burdened by high unemployment.
With the recent election of a moderate French President, the million-euro question is will the EU unite to provide fiscal relief to those member states where growth has lagged?
Fundamentals stronger than headlines suggest
Meanwhile, European economic fundamentals are much stronger than the headlines imply. Based on a workforce participation measure of employment, the eurozone recovery in employment has been stronger than that of the US.
The data suggests that, in the face of uncertainty, Europeans have deferred consumption, resulting in first a catch-up phase, followed by a more durable recovery. Further, with the euro trading close to its lows on a real effective exchange rate basis, trade competitiveness is adding fuel to the growth rebound.
Given the strength of the recovery, the ECB is considering normalising rates even as it keeps up its rate of QE – effectively reversing the order of tightening the Federal Reserve adopted. Why would it do this? Primarily to improve the profitability of the European banking sector by encouraging lending, while also keeping a lid on sovereign yield spreads.
Ironically, according to our Antipodes Partners’ valuation heat-map, one of the cheapest sectors globally is European financials, the direct beneficiaries of such a policy. Our Antipodes Global Fund – UCITS portfolio exposures here include ING Groep, Mediobanca, Unicredit and Erste Bank, with each business highly differentiated in its own right.
Given Europe’s status as a very large exporter of savings to the rest of the world, the knock-on effects of such a potential policy normalisation should not be underestimated.
While the Eurozone bond market and European domestic-facing equities are discounting a deep deceleration in growth – North American domestic-facing equities are discounting a reacceleration in growth. We believe it is highly likely both markets are mispriced.