If you are a keen student of financial literature, you would be forgiven for thinking that Europe is on the road to disaster. Rarely have we seen as much negative commentary as has been the case since the no-vote in France five weeks ago. Every newspaper, left or right wing, pro or against Europe, has been stuffed with articles suggesting that Europe is on the verge of collapse and that the euro is at risk of disappearing altogether.
Now we as human beings have a remarkable ability to see things as whiter that white when times are good and blacker than black when we find ourselves in stormy waters. Hence it is no surprise to see that most commentators are describing the current political crisis as if there is no tomorrow.
Whichever way you look at it, Europe is undeniably in its worst political crisis for at least a generation. At the same time, European equity markets continue to perform remarkably well. In fact, all European markets (with the exception of Slovenia) have outperformed the US market year-to-date. Why is that? Have these markets just lost all sense of reality only for it all to end in tears?
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Like everyone else, we have our favourite economists, analysts and columnists that we read regularly. Most of these observers have been negative on European equities for a while, and the recent political crisis has only reinforced this view.
It is actually not hard to build a very negative case for European equities. The political crisis is only the latest hiccup in a long string of setbacks for the old continent. Unemployment is rising. The consumer has virtually stopped spending. Several countries are now openly flirting with recession. And, to top it all, the demographic outlook is absolutely awful.
The problem with this line of thinking is that it is all old news. Very old news. Markets do not react to old news. Only proper news counts. The no-votes in France and the Netherlands were certainly proper news, but they sparked a political crisis, not an economic one, although it was portrayed as an economic crisis in the making by the majority of financial reporters.
Now, we would not hesitate to suggest that the collective brain powers of global financial markets are superior to those of the average financial reporter. Hence it is probably fairly safe to conclude that we should seek the answer to our opening question in the stock market's reaction to the crisis and perhaps quietly ignore all the doomsday reports.
Stephen Roach of Morgan Stanley is one of the leading advocates of the view that something good may come out of this crisis. Last week he wrote the following lines:
'I continue to feel that the angst over Europe's political disappointments is obscuring the meaningful progress being made on structural reforms. The failure of the EU constitutional referenda in France and Holland, in conjunction with the acrimonious ending to the recent European summit, does not undermine the case for structural change.'
We would go one step further and argue that the two referenda should actually strengthen the case for structural change. Not so much because of the no-votes themselves, but because the political process is likely to be changed as a result. Most importantly, we think several countries will have no choice but to become more inward looking, paying closer attention to popular demands. Effectively, the economic policies in several major countries will become more focused on growth.
The icing on the cake was delivered by the Prime Minister of Luxembourg who suggested that a re-vote should take place so 'voters could give the right answer'. That freaked even the most pro-EU of Europeans. In Luxembourg (and nobody is more pro-EU than the good people of Luxembourg), close to 50% of the electorate is now against ratifying the new EU constitution. An entire generation of narcissistic politicians effectively committed political harakiri in front of all of us, and that is the best that could possibly have happened.
Not that we particularly dislike the current generation of European leaders (well, perhaps we do, but that is a different story altogether). The fact is, Europe sorely needs new leadership. Chirac and Schroder have both run out of ideas.They may not be prepared to admit so yet, but their time is up.
The people of both Germany and France are asking for change. Some of the change required will be painful, and that requires strong leadership. Only time will tell if the next generation of leaders have it in them to force those changes through. Perhaps markets are telling us that things are not looking too bad in that department.
The Nordic countries have performed comparatively well. Admittedly, rising oil prices have supported both the Norwegian and the Danish stock markets (the latter due to Maersk accounting for approximately 1/3 of the KFX index). Yet, a large part of the explanation should be found in the way these countries have increasingly embraced the Anglo-Saxon economic model.
Yes, we know what you are going to say now and we fully agree. It is indeed a lot easier for a small country like Finland or Iceland to adapt to change than it is for Italy, France or Germany. But the UK did it, so it can be done. We believe markets are warming to early signs that the people of Germany in particular are ready to accept changes.
June was a surprisingly good month for European equities considering all the bad press. This also reflected on the Absolute Return Multi-Strategy Fund, which had another good month. If our assessment is correct, European equities should continue to do well for a while yet. Over the next several months, though, we would advise you to gradually move your exposure away from the Nordic region over to the larger markets such as Germany, as investors start to reward these for making structural changes.
By The Absolute Return TeaAbsolute Return Partners LLP is a London-based private partnership. They provide independent asset management and investment advisory services globally to institutional as well as private investors, charities, foundations and trusts.
To learn more about them, visit www.arpllp.com
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