Do European stocks need more QE to hit top gear again?
Legendary Prussian Field Marshal Helmuth von Moltke once noted “No plan of operations extends with any certainty beyond the first contact with the main hostile force.” And although he is not waging war in the physical sense, European Central Bank President Mario Draghi may have been well advised to bear this in mind before he declared victory in 2018 in his struggle to fend off both bears of the euro and recession in the Eurozone.
Mr Draghi stopped adding to the ECB’s three-year old Quantitative Easing (QE) programme in December, as he had said he would last June, when inflation was exactly in line with the central bank’s 2% target, compared to 0.3% when the bond-buying programme began.
Advisers, clients and Mr Draghi may have been tempted to think that the ‘hostile forces,’ to use von Moltke’s term, of deflation and currency speculators had been beaten back, especially as Germany’s DAX equity index and the wider Stoxx Europe 600 benchmark were trading at or near all-time highs.
Not so fast. As the ECB began to taper its QE scheme during the year, business confidence indicators, inflation, the euro and European stock markets all ebbed. Italy has even slipped into a technical recession, with two consecutive quarters of falling GDP.
Over the past 12 months, Western Europe outperformed only the Africa/Middle East region of the eight major geographic options available to advisers and clients, in sterling, total return terms.
Western European stocks have lagged in the last 12 months …
Source: Refinitiv data
This is because the Stoxx Europe 600 stock index began to lose altitude seemingly as soon as the ECB began to slowly taper its monthly QE scheme down to zero, from a peak of €80 billion a month.
… and the loss of momentum appeared to coincide with the tapering of QE
Source: Refinitiv data, European Central Bank
As a result, Mr Draghi used January’s ECB press conference to announce that the central bank was again ready to use all of its policy tools to combat any economic slowdown in Europe, including a relaunch of QE.
Coming just as the US Federal Reserve began to back away from interest rate increases and raise the prospect of halting its moves to withdraw QE, Draghi’s words have given European stocks a lift.
But advisers and clients must now decide whether this can last, given the underlying fragilities which even a tapering of QE in Europe – let alone any moves to withdraw it – appear to be unveiling and the possible failure of Draghi’s policy to halt QE to meet first contact with its enemies.
If one country has benefited from the ECB’s QE largesse it is Germany. Its export-driven economy has made the most of record-low interest rates and a competitive currency.
Yet even here the cracks are appearing. Whether this is down to the slowdown in car sales caused by a stiffer Worldwide Harmonised Light Vehicle Test (WLTP), concerns over global tariffs and trade, Brexit or even a modest tightening of monetary policy in the US and Europe can be debated.
But German industrial production has now dropped year-on-year in four of the past five months and December’s 4% slide was the worst decline since December 2009, right at the end of the recession that came out of the Great Financial Crisis. And where industrial production growth goes, Frankfurt’s DAX equity index seems keen to follow, if history is any guide.
Plunge in German industrial production makes grim reading …
Source: Refinitiv data, Destatis (Federal Statistical Office of Germany)
Given such woes, it is hardly surprising that German business confidence is on the wane. The monthly Ifo sentiment indicator is still holding up pretty well at 100 but any sustained drop below that would not necessarily be a good sign. More worryingly still, the gap between German companies’ view of their current trading and expectations for the future continues to widen, with more and more firms preparing for tougher times ahead.
… as does deterioration of the trading outlook at German firms
Source: Ifo Institute for Economic Research, Refinitiv data
If Germany’s slowdown does turn out to be nothing more than a blip caused by new car emissions testing requirements then sentiment – and equity markets – could turn around pretty quickly.
Besides the German headlines and ECB policy machinations, advisers and clients with exposure to European assets might also keep an eye on Belgian industrial confidence indicator the Courbe Synthétique index.
It does seem that the views of 6,000 Belgian industrialists provide a reasonably canny insight into the broader fortunes of Europe’s economy and stock markets. The next survey is, as it happens, due out on Friday 22 February.
Belgium's Courbe Synthétique is traditionally a good indicator for Eurozone equities
Source: National Bank of Belgium, Refinitiv data
Any improvement could give bulls of European stocks a lift, especially as it is possible to argue the Stoxx Europe 600 is far from expensive on 12 to 13 times forward earnings for 2019 after its recent bout of underperformance.
Equally, bears will growl that the Courbe is no higher now than it was in December 2015, despite the ECB’s efforts to boost and support markets alike. Sceptics may also be reluctant to go overweight on an asset class that appears reliant on its central bank monetary fix, from which it will surely one day need to be weaned.