While we believe that the euro area is off ‘the critical list’, its health remains fragile. This has been evidenced in anaemic first quarter growth data (-0.2% qoq). Europe’s ‘core’ countries have also been showing signs of economic strain, France contracting 0.2%, and German growth very weak at 0.1%. Underlying structural issues and political discord within the region are also reasons for caution. The agonising negotiations over the Cypriot bailout mean that investors should not become complacent about the risks within Europe’s banking system. The voice of protest in the periphery continues to make itself heard; in Greece, the Democratic Left party has pulled out of the country’s fragile coalition following a row about the future of the state broadcaster. Although real money growth points to perhaps a slightly better outlook than consensus forecasts would have us believe, and valuation measures appear favourable, we are not entirely convinced that fundamentals will change enough in order for the region’s potential to be released. So, weighing the risks, we are underweight Europe.
We worry more that the EM have become popular investment areas over the past decade and may be a crowded trade
China and the EM are a complex area, one that we are not confident about buying into just yet. While we are not particularly concerned about their growth prospects – even with a moderation in China’s output they should continue to expand at a faster pace than the rest of the world – we worry more that these have become popular investment areas over the past decade and may be a crowded trade (chart 2). Investors who perhaps had 1-2% exposure to the EM in the early nineties, may have as much as 15-20% allocated to the area today. Notably, some of the advantages that made EM a compelling story back then – weak currencies and cheaper labour costs – have lost their sparkle. China has been losing economic competitiveness globally due to substantial wage growth and skills shortages. The Politburo’s measures to restrict property price appreciation and a clamp-down on the shadow banking sector have made for a bumpy ride. Investors will be looking for clearer announcements about fiscal policy and urbanisation plans in order to become more comfortable about the direction of Beijing’s reform agenda.
Chart 2: Post-crisis fund flows
Slowly but surely?
In the UK, there are, perhaps, more reasons to be cheerfulthan the press would have us believe. While growth has been lukewarm at best (first quarter GDP +0.3% qoq), investors could be underestimating the impact of some of the coalition government’s initiatives to kickstart the economy. Extra assistance for home buyers through the Funding for Lending and Help to Buy schemesappears to be feeding through to the housing market. According to the latest figures from the Council of Mortgage Lenders banks lent more to would-be homeowners in May than at any time since the autumn of 2008. At the same time, sterling weakness has been quite beneficial to Britain’s manufacturers, who have been enjoying a stronger-than-expected rebound in business. Lastly, the change of governorship at the Bank of England (BoE) as Mark Carney takes to the helm as governor is potentially very significant. Mr Carney is likely to be more tolerant of inflation given his comments regarding nominal GDP targeting.
Although the UK has experienced a long period of above-target inflation this has not destabilised medium-term inflation expectations, meaning that Mr Carney may have a little more scope than perhaps people think to adjust the bank’s mandate towards growth and reaching ‘escape velocity’.
Opinion column by Bill McQuaker, Deputy Head of Equities for Henderson Global Investors.