Enjoy Europe’s rally while it lasts
European stocks have had a good run so far this year. Just don't bank on it continuing.
When 2017 began, most investors were looking forward to a hefty stimulus package for the US economy from Donald Trump. Instead, the big story of the year so far has been Europe's recovery, says Chris Giles in the FT. The single currency area outstripped America in the first quarter, and its outperformance stretches further back. Despite the 2015 Greek drama, the eurozone has expanded by 5.1% in the past two and a half years, compared with 4.6% for the US.
And the expansion is gathering momentum. Consumer confidence has just reached a ten-year high. Corporate lending growth has hit a post-crisis peak. A survey of purchasing managers in both the manufacturing and service sectors points to the fastest growth in six years. Employment in the manufacturing sector is climbing at one of the fastest rates seen in the past decade.
This quarter alone the eurozone economy is likely to expand by 0.7%. Germany is leading the charge, but the periphery is also showing signs of life. Italy and Portugal expanded by 0.4% and 1% respectively in the first three months of 2017. Europe is also much more exposed to global growth than Britain or the US, so the uptick in the global economy will help it more. All this explains why Goldman Sachs expects earnings for the companies in the pan-European Stoxx 600 index to jump by 15% this year. Throw in modest valuations, especially compared with Wall Street, and European stocks look set fair.
So what could go wrong? Italy. Its huge debt load and rotten banking system are recurrent headaches although as Philip Aldrick says in The Times, a growing economy and bond-buying by the European Central Bank (ECB) will prevent a crisis for now. But what Italy "cannot manage is political risk". A national election may now be held this autumn rather than next year, and the anti-euro populist Five Star movement is on a par with the governing centre-left Democratic Party in the polls.
The populists have promised a referendum on Italy's euro membership. That would spook bond markets and prompt a sell-off of Italian debt, propelling bond yields and hence implied borrowing costs upwards. The ECB could stem the tide by buying more Italian debt, but the crisis would dent confidence and probably abort the recovery. So investors should enjoy European equities'rally while it lasts. Later this year, the crisis could make a comeback.
The subprime car bubble
History seems to be repeating itself, says Wirtschaftswoche. The US car-loan market is spookily reminiscent of the mortgage market before the crash of 2008. Eighty-six percent of new and 55% of second-hand cars are bought with borrowed money, and lenders seem happy to throw cash at pretty much anyone with a pulse. The total value of US car loans has soared by 40% to just over $1.1trn since 2007. A third of debtors are officially subprime borrowers, and a third of those are in the "deep subprime" category: people who barely have a hope of servicing their borrowings "without winning the lottery". In 2010 only 5.1% were deep subprime.
As with the subprime mortgage market, lenders have packaged up the dodgy loans and sold them on. Air is hissing out of the bubble. Second-hand car prices are falling and will slide further if people have to sell because they can't meet payments: 5% of subprime loans are 60 days in arrears. The subprime car market, unlike the $9trn mortgage market, is too small to sink the economy. But it could tear some big holes in hedge funds' portfolios and give the markets a nasty fright.