Life after Brexit: Will the European economy rebound? | Capital Group Canada | Insights

Insights

ARTICLES  |  OCTOBER 2019

Life after Brexit: Will the European economy rebound?

Featuring
Carl Kawaja, portfolio manager
Robert Lind, economist
Jens Sondergaard, currency analyst

Capital Group investment professionals Robert Lind, Jens Sondergaard and Carl Kawaja discuss their outlook for the eurozone economy and European company investments.


Key Takeaways

  • The European economy is struggling with global trade disruption and political turmoil.
  • Central bank officials are responding with another substantial dose of monetary stimulus.
  • Despite economic headwinds, company-specific investment opportunities remain.

 

It’s been another disappointing year for the European economy, even though 2019 is only two-thirds done.

The United Kingdom is beset with Brexit uncertainty. Germany is teetering on the verge of recession. Protests in the streets of Paris until recently threatened to destabilize the French government. On top of all that, global disruption from the U.S.-China trade war has weighed heavily on Europe’s export-dependent economy.

“I doubt many Europeans will be sad to see 2019 fade into history,” says Capital Group economist Robert Lind. “It’s been a tough year politically, economically and in the broader societal context.”

However, there is reason to think 2020 will be better, Lind explains. There are several important “ifs” in play: If a truce can be negotiated on the global trade front, if central bank stimulus measures do their job and if a Brexit resolution is finally achieved, those events could remove the large cloud of uncertainty that has hampered European economic growth in recent years.

Stimulus on the way

“Broadly speaking, I think the European economy should gradually start to show signs of improvement in 2020 as some political risks begin to diminish and as looser monetary and fiscal policy work their way through the system,” Lind says.

The European Central Bank (ECB) last month cut its key policy rate further into negative territory, from –0.4% to –0.5%. ECB officials also said they would relaunch a €20 billion per month bond-buying program in a bid to spark inflation and jumpstart the European economy. Many eurozone governments also have been loosening fiscal policy to help the cause.

Inflation has been running far below the ECB’s target rate of roughly 2% a year, and GDP growth has hovered around 1% on an annualized basis. That’s about half the growth rate of the U.S. economy.

Outgoing ECB President Mario Draghi said aggressive stimulus measures are necessary to help offset the damaging effects of trade wars and slowing economic growth around the world. Draghi’s successor, former IMF chief Christine Lagarde, is expected to continue advocating for Draghi’s policies when she takes office November 1.

Another unique challenge to the European economy: the U.K.’s bid to leave the European Union. The U.K. faces an October 31 deadline to approve a hotly debated withdrawal agreement, although it now appears likely that British lawmakers will seek another extension in the long-running Brexit negotiations.

Meanwhile, Germany is nearing a recession as the U.S.-China trade dispute hammers the German manufacturing sector, particularly the auto industry. Germany’s economy shrank by 0.1% in the second quarter and is expected to fall further when third-quarter data is released. A recession is commonly defined as two consecutive quarters of negative growth.

Currency tailwind coming?

Since the ECB’s September rate cut, the euro has continued to weaken, extending a trend that has continued for years. On a year-to-date basis, the euro has declined more than 4% against the U.S. dollar as negative interest rates in the eurozone (coupled with higher rates in the U.S.) have made U.S. dollar-based assets generally more attractive to investors.

The dollar is significantly overvalued against the euro, says Jens Sondergaard, a Capital Group currency analyst. Once that trend reverses course, he notes, it could provide a nice tailwind for euro-denominated assets.

Sondergaard expects the dollar to weaken in 2020–21 as U.S. economic growth softens, but he concedes that currency movements are notoriously difficult to predict. In the short term, the euro could fall further as the U.S. and European economies diverge.

“The relationship between interest rates and currencies has essentially broken down in a negative-rate world,” Sondergaard says. “We shouldn’t expect that correlation to return anytime soon. The more important drivers of currency movements today are relative bond flows and relative growth expectations.

“So, the big question is, can the euro rally when the U.S. economy starts to weaken?” Sondergaard asks. “That remains to be seen.”

chart-bond-yields-916x476

Investment implications

Despite the economic headwinds, or perhaps because of them, Europe is a classic stock-picker’s market, says Carl Kawaja, Capital Group Global Equity FundTM (Canada) portfolio manager. Investors can’t rely on robust economic growth to lift share prices, which places more emphasis on company fundamentals.

“Uncertainty creates opportunity,” Kawaja says. “We like it when things are a bit murky and difficult to figure out. In this type of environment, we are finding no shortage of compelling opportunities in Europe, both from a growth perspective and from a valuation perspective.”

On the growth side, Kawaja looks for fast-growing companies that are disrupting their respective industries. On the value side, he sees interesting opportunities in some hard-hit European auto companies.

chart-valuation-pairs-916x420

It is important to note that although European stocks have continued to lag U.S. equity markets this year, European returns have still been solid on an absolute basis. As of September 27, the MSCI Europe Index is up 14% in U.S.-dollar terms and more than 18% in local currency. By comparison, U.S. stocks have gained nearly 20% so far this year, as measured by the S&P 500 Index.

Although European economic growth has been disappointing so far in 2019, investment returns have charted a decidedly different course — which serves as a timely reminder that the economy and the stock market aren’t always on the same page.

 

About

 

Carl Kawaja Portfolio manager, Capital Group Global Equity Fund (Canada)

Carl Kawaja is a portfolio manager with 32 years of investment experience, 27 at Capital Group. Earlier in his career, as an equity investment analyst at Capital, he covered global household products and U.S. personal care companies, along with Canadian companies. He holds an MBA from Columbia and a history degree from Brown.

Robert Lind Economist

Robert Lind is an economist with 31 years of industry experience. He previously worked as group chief economist at Anglo American and was head of macro research at ABN AMRO. He earned his bachelor's degree at Oxford.

Jens Sondergaard Currency analyst

Jens Sondergaard is a currencies analyst with 13 years of experience, six at Capital Group. Earlier in his career at Capital, he worked as an economist covering the eurozone and the U.K. Prior to joining Capital, he was a senior European economist at Nomura, a senior economist at the Bank of England and an assistant professor at The Johns Hopkins University. He holds a PhD in economics and a master's in foreign service from Georgetown.


Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

Unless otherwise indicated, the investment professionals featured do not manage Capital Group‘s Canadian mutual funds.

References to particular companies or securities, if any, are included for informational or illustrative purposes only and should not be considered as an endorsement by Capital Group. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds or current holdings of any investment funds. These views should not be considered as investment advice nor should they be considered a recommendation to buy or sell.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not be comprehensive or to provide advice. For informational purposes only; not intended to provide tax, legal or financial advice. We assume no liability for any inaccurate, delayed or incomplete information, nor for any actions taken in reliance thereon. The information contained herein has been supplied without verification by us and may be subject to change. Capital Group funds are available in Canada through registered dealers. For more information, please consult your financial and tax advisors for your individual situation.

Forward-looking statements are not guarantees of future performance, and actual events and results could differ materially from those expressed or implied in any forward-looking statements made herein. We encourage you to consider these and other factors carefully before making any investment decisions and we urge you to avoid placing undue reliance on forward-looking statements.

The S&P 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2019 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC.

Bloomberg® is a trademark of Bloomberg Finance L.P. (collectively with its affiliates, "Bloomberg"). Barclays® is a trademark of Barclays Bank Plc (collectively with its affiliates, "Barclays"), used under licence. Neither Bloomberg nor Barclays approves or endorses this material, guarantees the accuracy or completeness of any information herein and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

MSCI does not approve, review or produce reports published on this site, makes no express or implied warranties or representations and is not liable whatsoever for any data represented. You may not redistribute MSCI data or use it as a basis for other indices or investment products.

Capital believes the software and information from FactSet to be reliable. However, Capital cannot be responsible for inaccuracies, incomplete information or updating of the information furnished by FactSet. The information provided in this report is meant to give you an approximate account of the fund/manager's characteristics for the specified date. This information is not indicative of future Capital investment decisions and is not used as part of our investment decision-making process.

Indices are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

All Capital Group trademarks are owned by The Capital Group Companies, Inc. or an affiliated company in Canada, the U.S. and other countries. All other company names mentioned are the property of their respective companies.

Capital Group funds and Capital International Asset Management (Canada), Inc. are part of Capital Group, a global investment management firm originating in Los Angeles, California in 1931. The Capital Group companies manage equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.

The Capital Group funds offered on this website are available only to Canadian residents.


Related Insights