Follow the money and you can see how bleakly investors view eurozone equities, displaying little confidence in the robust bounce for the region’s share markets this year.
In the absence of new money entering a stock market, prices can rise, nurtured by corporate buybacks, equity derivatives trading and hedging flows, alongside exits from bearish bets and sector rotations. Ultimately, the infusion of new blood is the signal that investors think the market is worth owning.
But for now, as flow data from EPFR reveals, money is still leaving eurozone equity funds, which ended April with their 12th consecutive weekly outflow.
Such caution reflects concern that the region is on a Japan-style journey into a prolonged era of low growth and low inflation. The comparisons extend to a banking system working through legacy poor loans, an issue that hobbles financials that are a big value play in eurozone equities alongside an ageing population that leaves central bank policy stuck in a negative gear.
A look at eurozone interest rates, German Bund yields and inflation expectations over the past few years illustrates how the region is feeling the pressure after a previous bout of macro worries from 2015 into 2016. Another sniffle in China, the driver of the modern business cycle, has duly infected the eurozone with a bad case of the chills.
With the European Central Bank missing its inflation target and having limited scope for easing policy from current levels, the region remains structurally vulnerable to a macro shock. While a 10-year German Bund yield confined around zero helps support equities as seen in recent months, that hardly represents a reassuring sign about the region’s long-term prospects.
One sliver of comfort: BNP Paribas notes that unlike Japan, “the eurozone’s labour market structures are less likely to allow wage growth to slow sharply’’.
There was also some relief this week as the eurozone economy grew 0.4 per cent during the first quarter, double the pace seen in the preceding three-month period. This bounce from a low base still leaves the region shy of its 2017 growth pace when the global economy nestled in a very sweet spot.
Any discussion about the outlook for the eurozone quickly brings us back to China and whether Beijing can engineer the kind of recovery that helped drive the global economy into a higher gear after its prior wobble.
The answer remains inconclusive at this stage and one interesting observation about the past couple of weeks is how Shanghai and Shenzhen equity markets have fallen 5.9 per cent and 8 per cent respectively from their mid-April peaks. The CSI 300 index of leading A-shares has eased 5 per cent from this year’s high on April 19.
Sure, this retreat may just represent a necessary breather after a very impressive climb since January. An index of industrial metals, dominated by copper, has eased to levels seen in February over the past month. Also troubling is how trading partners reliant on China such as Japan, South Korea and Taiwan are not cresting the sunlit uplands in economic terms, casting doubt on Beijing’s stimulus efforts rippling globally.
This represents the key long-term challenge facing investors positioned in emerging markets along with those who have been bottom fishing in European equities, particularly Germany.
Silvia Dall’Angelo at Hermes Investment Management notes “a much broader structural change in the Chinese economy, as it transitions to a more mature phase’’ and that leaves the eurozone and Germany in a tough spot.
“Policymakers in Germany must attempt to mitigate the risks posed to their own economy, and that of Europe by extension, by the Chinese structural slowdown. They should prioritise the stimulation of consumption and private investment by reforming the tax system and regulation.”
For investors looking long-term across Europe, the key question is whether such reforms will really happen as European Parliament elections loom at the end of May.
Very rarely in conversations with fund managers in recent years have I heard a long-term eurozone bull undeterred by the obstacles posed by fundamental reform in the region.
The winds of change start with fiscal policy, led by the likes Germany that have room to expand their borrowing to the benefit of the euro region.
Steen Jakobsen, chief economist at Saxo Bank, reckons the fourth quarter should mark the moment of greater fiscal spending after summer shows little sign of economic activity picking up.
‘’There is room to expand spending and a lot of infrastructure can be carried out by European companies.’’
That ultimately should make a stronger case for owning European equities, but the current fund outflows highlights the doubts of many investors on that score.