European equities were the classic ‘pain trade’ of 2017, the bull market’s wall of worry was scalable, even a slam dunk. Geert Wilders and Marine Le Pen were defeated in the Dutch and French election, reducing political risk in Europe. Greece got its latest bailout tranche from the IMF, EU and Berlin. Europe’s PMI were stellar in the 55–57 range. Dr Draghi’s hawkishness at the last ECB conclave led to a steeper German yield curve, a steroid shot for the bank stocks that dominate the Euro Stoxx 600 index. The momentum of the herd was only amplified after Italy bailed out Banca Veneto and Banco Popular di Vicenza with a €19 billion lifeboat without inflicting losses on junior debt holders. Bella Italia once again defied the Teutonic Fatherland with total impunity. Achtung baby, Frau Mutti!
I find it laughable that every strategist I meet is long Europe, making this the mother of all consensus trades now. This scares me because the madness of crowds never leads to a Thomas Hardy pastoral idyll but to a positioning Wile E. Coyote fall off a cliff moment when the music stops, as it always does. So European earnings revisions now threaten to turn negative. This means EPS growth estimates for 2018 will be slashed this autumn. The Five Star Movement in Italy (and the Northern League and Forza Italia!) is both populist and anti-euro. The UK’s Tories are mired in post-election angst and political nights of the long knives even as Brexit and a weak sterling hit UK consumer spending. When profits and liquidity peak, as they will this summer, I fear for the stock markets of the Old World. I would even argue that this is the moment when the dreams of Jean Monet and Robert Schumann, the spirit of the Treaties of Rome, Maastricht (and Westphalia!) face the demons of xenophobia and nationalism that led to the killing fields of Europe in the 1940s. Yet the European project was born in the court of Charlemagne, king of the Franks, more than a millennium ago in the Holy Roman Empire, the original Thousand Year Reich. The EU will survive Brexit but not Italexit.
The Federal Reserve’s rate hikes and balance sheet shrinkage in 2017-18 mean the ECB will also decelerate the momentum of its easy money policies. This means the German Bund yield rises and hits the stratospheric valuation of consumer and technology shares in Europe. Eurozone GDP growth rises to 1.8% (Spain is above 2% even now). My favourite sectors in Europe remain banks and insurers as they benefit most from a steeper yield curve, a fall in credit default swaps, the Greek IMF loan deal, Franco-German rapprochement after Brexit/Trump and Deutschland AG’s export momentum. SocGen in Paris, Credit Suisse in Zurich, ING in Amsterdam, Allianz in Frankfurt and Banco Santander in Madrid are my Big Five European financials.
The euro has soared to 1.14 after Draghi’s reference to reflation in his last ECB showtime speech, the trigger for the German Bund ‘taper tantrum’. Yet the 7% fall in the US Dollar Index to 96 is also a testament to the failure of President Trump to inspire confidence in the prospects for tax reform and significant fiscal stimulus, let alone his failure to repeal and replace Obamacare. It is now possible that the euro will retest its May 2016 high, my strategic target.