The emotional European rollercoaster shows no sign of ending, but at least we think that the doomsday scenario has been put off by Mario Draghi and the European Central Bank (ECB), although the day of eventual reckoning might simply have been delayed.
Our simple conclusion is that Mario has bought European leaders more time and they should be thankful for that. We believe that quantitative easing (QE) can offer a short term pump-prime effect to the European economy and help the recent improvement in the money supply.
We also think the recent, and much welcomed, outperformance of European stocks over the US can continue and investors should position themselves for this possibility.
Performance of indices over 5 yrs
Source: FE Analytics
The devil was always going to be in the detail of the QE programme. Given that many of the headlines of today's policy announcement were leaked yesterday afternoon, either purposely or mischievously, there were not a huge amount of surprises.
The ECB announced that starting in March of this year they will be buying €60bn of European countries bonds each month through to the end of September 2016. This equates to c€1.2trn over the duration and an upside surprise on the market's original expectation of c€600bn.
Will it work? Let's make no mistake about this; we do not see QE as a panacea for the European economy, it is merely (another) sticking-plaster.
The political classes and central bankers would see far greater medium-term results if they were to ignore the temptation to meddle in markets and were to use the money better in investing in vitally-needed infrastructure and, at the same, reform their unwieldy labour markets.
But I don't live in dreamland (yet) and this isn't going to happen any time soon. However, we feel that a combination of this programme, the already-announced asset-backed securities purchase programme and targeted refinancing operations should bring some confidence around the banking sector and allow asset markets to perform well.
Whether the governments of stagnant Europe use this breathing space afforded by Mr Draghi to their advantage will be the key to the ultimate success of his various programmes.
Angela Merkel (ironically speaking in Davos at exactly the same time as Draghi) today said that “the clock is ticking on European structural reform”; we think the clock in many places needs fresh batteries.
What QE won't do is force banks to lend, which is a vital step in the Lazarus path that Europe needs. It is pleasing to recently see that banks have reduced lending standards, which should offer some comfort and much-needed cash to the small and medium enterprises, which cannot go to the bond market to raise money.
To get really bullish on Europe we would want to see a normalisation in the supply of credit and an improved willingness to lend and invest by companies. This would hopefully allow the same trajectory of improvement as we have seen in the US in the last few years. However, it might well be wishful thinking.
What does this mean for portfolios? We remain overweight European equities and like selective European credits, including distressed debt and asset-backed securities.
Some equity investments have gained quite a lot in the last few weeks, so investors should expect volatility, but we expect further progress through this year. Investor positioning suggests that global investors remain light on European equities, particularly global equity funds and the “pain trade” for most is further gains in European stocks.
If you are feeling really brave then look no further than the Italian banks; European equities are as cheap as they have been relative to global benchmarks (which are dominated by the US), while Italian stocks are as cheap as they have been versus wider Europe and Italian banks are as cheap as they have been in their history relative to Italian stocks. Some Italian bonds trade on 0.4-0.5xs price to book.
If Draghi acts to stem the worst fears over Europe then these banks could be a great trading buy. This doesn’t mean we are bullish on the Italian economy (let’s not forget that the economy there has not grown in real terms for 15 years) but certain stocks offer recovery potential.
In summary, let’s hope that European governments take the chance to act to turn their hunkering old ship toward a more promising horizon. That seems unlikely based upon recent experience but even if they don’t then this historical day in Europe should help drive European assets higher.
Tom Becket (pictured on page one) is chief investment officer at Psigma Investment Management. The views expressed above are his own and should not be taken as investment advice.