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The Eurozone debt crisis a decade ago was grim for all concerned. Even aside from the impact on people’s lives, every lurch lower in the euro felt a step towards the brink of an even greater calamity.
One striking feature of that period, though, was that it showed Europe does take decisive action when its markets — particularly its bonds and currency — are in freefall. In that narrow sense, investors in the region could really do with a flashback to that time now.
Despite political dysfunction in core EU members France and Germany and a generally sluggish economy, European stocks are not having a terrible year. The Euro Stoxx 600 index is up by a little over 5 per cent. Some domestic indices, including Germany’s Dax and Italy’s FTSE MIB, are comfortably in double figures.
The problem is that the US is pulling ahead at a fast enough pace that fund managers could be forgiven for wondering if Europe is worth the bother. The gap in valuations between American and European stocks (in favour of the US, if that was not obvious) is nothing new to this year, nor even to this decade. But it has yawned wider since the US made such a startling success of its tech industry.
Indeed, in September, former European Central Bank president Mario Draghi released a long and detailed report addressing the many and varied ways in which the EU had failed to keep pace with the US in terms of competitiveness, and financial market cohesion. The Draghi report, as it is widely known, is intended to be a galvanising force that brings about real and urgent change, boosting ambition and slashing the burden of regulation.
This is, of course, a noble effort. But it does send an awkward signal. “Even the existence of the Draghi report tells you everything,” said Angus Parker, head of developed markets at USS Investment Management, at a Financial Times event this week. “OK, in the US we had the Inflation Reduction Act, we had the Chips Act, but the US hasn’t had to produce a Draghi report for growth.”
This disparity is well established. But the US has really rubbed Europe’s nose in it over the past week or so.
Since the re-election of Donald Trump as president, the benchmark S&P 500 index of US stocks has sprung more than 4 per cent higher, demolishing several record highs in the process. The more domestic-focused Russell 2000 index of smaller US companies jumped as much as 10 per cent before calming down a little. Rather than being swept up in all the excitement, the Euro Stoxx 600 index has crept lower over the same period.
Meanwhile, Eurozone government bond markets are pretty ugly. Germany’s benchmark government bonds, generally the safest (if dullest) spot for investors in the region, have been sliding in price, taking yields up to 2.3 per cent even while the European Central Bank is expected to keep cutting rates. Meanwhile, Italy, supposedly the currency bloc’s problem child, is a sea of tranquility, with yields around 3.5 per cent. When investors and politicians talk about Eurozone yield convergence, they generally mean a collective push down to German borrowing costs, not a sweep up to Italy’s, but here we are.
Similarly, the euro has dropped, shedding 3 per cent of its value against the dollar just since the election, to a little under $1.06. This is the market’s way of saying American exceptionalism is alive and well.
Europe’s markets find themselves dragged down by the persistent economic weakness of China — a key export market — and by the sparkling outperformance of the US — a smarter, more handsome cousin with better teeth and, seemingly, with an aggressive set of trade tariffs up its sleeve that will hurt even more.
“I talk to clients and there’s a very deep scepticism that Europe can come up with a quick [response] to shore up demand,” said Karen Ward, a strategist at JPMorgan Asset Management at an event this week. Interest rate cuts will help, Ward said, but they were unlikely to be enough without some politically tricky fiscal intervention and a direct counter to what ever tariffs the US eventually delivered.
The drab performance of European stocks put the region at a real “fork in the road”, said Altaf Kassam, a managing director at State Street Global Advisors. “Some tough decisions have to be made,” he said, to win back investors’ affection.
But investors who remember how swiftly the EU responded to the outbreak of Covid-19, and, albeit falteringly, to the darkest points of the Eurozone debt crisis, know that when market moves get really ugly, policymakers do respond. A drop to $1 in the euro should not be needed to focus minds, but it would instil a deeper sense of urgency.
European authorities need to demonstrate they are serious about boosting competition and fending off the threats posed by the tariffs that president-elect Trump has vowed to enact, investors say.
“We’re good at crises,” said Drew Gillanders, head of international equities for Europe at hedge fund Citadel, also at the FT’s event this week. “The value of a crisis is, you use it. And now is the time to use it.”
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