Abu Dhabi, UAESaturday 4 April 2020

With Europe the centre of the pandemic, what should investors be focusing on?

The Euro Stoxx 50 index is down about 32% this year as the continent struggles to contain Covid-19

European Central Bank president Christine Lagarde was slow to respond to the crisis, initially saying the central bank was “not here to close spreads” before changing her stance. Reuters
European Central Bank president Christine Lagarde was slow to respond to the crisis, initially saying the central bank was “not here to close spreads” before changing her stance. Reuters

How do investors approach a problem like Europe? While every economy across the globe has been shaken by the Covid-19 storm, the continent looks particularly vulnerable, because it is still battling to recover from the 2008 financial crisis.

Right now, Europe finds itself at the centre of the coronavirus pandemic that has infected more than 307,000 people and killed 13,049, according to Johns Hopkins University which is tracking the outbreak. More than 92,300 people have recovered. On Saturday evening, Italian officials recorded 793 dead and 6,557 new cases in just one day. Italy's total death toll has now surpassed China, with the total number of confirmed coronavirus cases now more than 53,000.

We are already seeing signs that the Chinese economy is starting to recover. There is no reason why Europe should not be able to replicate the same pattern over the next few weeks.

John Greenwood, Invesco

Spain has more than 25,000 cases, the world’s third highest after China, with latest figures showing the death toll jumping 300 in a day. In France, the death toll jumped by 112 to more than 560, while and Germany has seen 84 deaths so far. All these numbers are expected to rise sharply.

Unsurprisingly, share prices are crashing, like everywhere else. Year-to-date, the Euro Stoxx 50 index has fallen around 32 per cent, closing at 2,548 on Friday evening. So should investors abandon Europe – or view this as a buying opportunity?

Even before the coronavirus outbreak, Europe was on a go-slow, with gross domestic product growing just 0.1 per cent in the fourth quarter of 2019, according to estimates by Eurostat, the EU’s statistical office. This was the slowest since 2013, trailing a relatively healthy 0.5 per cent in the US. Germany was flat, Italy fell 0.3 per cent, while France slipped 0.1 per cent.

Europe has political problems too, with the sovereign debt crisis and refugee numbers fuelling populism, and Brexit adding to its woes.

The EU single currency remains an arguably flawed project, as Portugal, Italy, Greece and Spain struggle with an overvalued currency. Now Europe finds itself in the eye of the Covid-19 storm.

Its initial response was underwhelming. European ideals seem to be under threat, with individual companies closing borders, going against the Schengen free travel area, while Germany’s move to block the export of medical masks and protective gear to Italy made a mockery of the single market.

The European Central Bank’s initial stimulus attempt on March 12 was seen as inadequate, as it held interest rates at minus 0.5 per cent, rather than pushing them deeper into negative territory. The Euro Stoxx 600 index responded by falling 11 per cent, its worst day on record. Germany's DAX and France's CAC 40 plunged more than 12 per cent.

ECB president Christine Lagarde initially made a bad situation worse by saying the central bank was “not here to close spreads” between the borrowing costs of member states.

Italian bond yields soared while the Milan stock exchange fell 17 per cent. Ms Lagarde subsequently apologised, insisting that the ECB was “fully committed to avoid any fragmentation in a difficult moment for the euro area”.

John Greenwood, chief economist at Invesco, says the initial ECB response was timid and trivial, but last week saw a sea change in official thinking. "It has seemingly overcome many of the legalistic restraints and the intellectual orthodoxy by which it has been trapped over the past decade,” he says.

Wednesday's massive €750 billion (Dh2.96bn) Pandemic Emergency Purchase Plan looks like the real deal, equivalent to 16 per cent of the ECB’s balance sheet, he says. "ECB leadership has grasped the scale of the task, as business, social and sporting events shutdown, supply and payment chains are interrupted."

Europe must now follow China's lead and enforce lockdown measures to reduce infection rates, Mr Greenwood adds: "We are already seeing signs that the Chinese economy is starting to recover. There is no reason why Europe should not be able to replicate the same pattern over the next few weeks.”

David Zahn, head of European fixed income at Franklin Templeton, says the ECB is rebuilding its credibility while individual countries are also taking action, with Germany committing up to €550bn, equivalent to 15 per cent of the country’s GDP, France launching a €300bn stimulus package, and Spain pledging €200bn.

The sudden stop of European economies will nonetheless inflict “a sizeable hit to GDP”, Mr Zahn adds, as nobody knows how long the lockdown will last.

Even if it does solve the crisis, Europe will still have troubles. Economists at Dutch bank ING predict the growth rate will slow to a crawl, as average EU growth of 1.4 per cent a year over the last decade falls to a meagre 1 per cent. Italian stagnation is set to be far worse than Japan, which has endured two lost decades.

Making matters worse, Europe also has poor demographics, with a relatively elderly population and low birth rates.

The hope is that the coronavirus crisis will spur the authorities into much-needed reforms, and will get the country's stock markets moving again.

After the initial retreat within individual country borders, European countries have taken co-ordinated action to quell the pandemic, says Antonio Serpico, European fixed-income specialist at fund manager Neuberger Berman, and the ECB is pulling out all the stops. “Total stimulus is equivalent to 9 per cent of European GDP, against just 4 per cent currently in the US," he adds.

Vijay Valecha, chief investment officer at Century Financial in Dubai, says the ECB and eurozone governments have finally risen to the occasion, and this bodes well for the continent's economy and stock markets. “Contrary to public expectations, the EU is not imploding and it is acting in solidarity with its most affected member, Italy.”

Mr Valecha says this crisis could actually be a turning point for EU: “Once it is over, it needs to focus its energy on other pressing issues such as reforming European labour rules, the pension system and tackling the lack of technological innovation.”

Italy remains under a nationwide lockdown. Reuters
Italy remains under a nationwide lockdown. Reuters

Recent falls could be a buying opportunity, but only if you are investing for the long-term, to allow time for the coronavirus threat to recede.

For those looking to play the European recovery, Mr Valecha tips individual company exchange traded funds (ETFs), including iShares MSCI France ETF and iShares MSCI Germany ETF.

He also highlights ETFs targeting specific sectors of the European economy, such as SPDR MSCI Europe Communication Services UCITS ETF, SPDR MSCI Europe Health Care UCITS ETF, and SPDR MSCI Europe Consumer Staples UCITS ETF.

Europe is finally pulling together in a crisis. The question now is whether current unity can be sustained, once the panic recedes.

The key thing to remember is that European stock markets have performed well, even if GDP growth has idled. The continent remains the home of some top global companies, including financial services firms AXA, Allianz and BNP Paribas; energy firms Total and E. ON; car manufacturers Volkswagen, Daimler and BMW; consumer goods producers Nestlé and Danone; telecoms firms Telefonica and Deutsche Telekom; and pharmaceutical businesses Bayer and Roche Holdings.

Last year, the MSCI Europe Index rose 26.88 per cent, only slightly behind the MSCI World average of 30.76 per cent.

Europe can still cut it, and merits its place in a globally balanced portfolio. Now could be a good time to get exposure, if you are feeling brave enough to buy shares today, and are willing to hold them for the long-term.

Updated: March 22, 2020 04:03 PM

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