- European unity is fueling a rally across markets in the region
- Goldman says Europe’s stocks will outperform against the U.S.
Since the birth of the euro two decades ago, the currency has faced no shortage of critics that a monetary union without a fiscal union would be dysfunctional and doomed to fail.
Now, after a landmark rescue package spearheaded by Germany and France, Europe has taken a step closer to fiscal integration — at least during times of severe crisis. The newfound sense of regional unity is winning the hearts and minds of investors, and has sparked rallies in everything from German stocks and Italian bonds to the euro itself.
The deal “removes a lot of the fragility of the whole eurozone,” said Patrick Armstrong, chief investment officer of Plurimi Wealth LLP, which manages $3.8 billion in London. “It shows that in times of stress you have essentially a fiscal union when needed.”
Armstrong says he changed his mind on the euro after the deal, and is now bullish. He thinks the currency could strengthen to $1.20 by the end of the year from $1.16 currently.
Italy’s 10-year bond yields have fallen below 1% for the first time since March. European stock funds saw the biggest weekly inflows in more than a month, according to a July 17 report from Bank of America Corp. that cited EPFR data.
European equities, which have underperformed against the U.S. for the past decade, are poised to start winning out, said Goldman Sachs Group Inc. strategists led by Sharon Bell. The bank expects European stocks to return 13% in dollar terms over the next 12 months, more than the U.S. or Asia ex-Japan.
“A lot of global investors have seen Europe in the past as a model that was questionable,” said Gary Kirk, a money manager at TwentyFour Asset Management in London, which manages $22.5 billion. “It definitely improves the perception of Europe.”
He’s bullish on European credit markets, and added to bond holdings of Spanish banks after the deal was announced.
No one is expecting a full-blooded fiscal union and the recovery package is temporary and limited by design, but it sets precedent for officials to revisit in future. With Italy and Spain mired under heavy levels of debt and in the throes of a deep recession, the rescue fund is a bulwark for European solidarity.
For the first time, the EU will sell joint debt to fund a 750 billion-euro ($870 billion) emergency package. It raises new questions about whether the bonds can rival Treasuries as a safe asset, and if the euro can now pose a credible challenge to the dollar’s hegemony.
“Europe is a huge economy that doesn’t have a single safe asset and that drives a whole lot of inefficiencies,” said Andrew Sheets, a cross-asset strategist at Morgan Stanley. With the recovery deal “you potentially create a new class of AAA-rated jointly backed debt that is a safe asset for the eurozone.”
Other investors view the European rally as an unsustainable one-off, given the region’s bleak economy. In the euro area, unemployment could hit almost 10% by the end of the year as the economy slumps, according to a Bloomberg survey.
“I am looking at this rally as an opportunity to sell the last of my position in European banks,” said Manish Singh, chief investment officer at Crossbridge Capital. “The economic malaise in the EU is not going away.”
For investors comparing the U.S. against Europe, the recovery deal is enough to tip the balance. As Covid-19 deaths in Texas and Florida surpass new records and the November election looms, there are a lot of reasons to be skittish about American markets, says Andreas Meyer, a fund manager at Aramea Asset Management.
He expects European credit markets to outperform the U.S., and bets the euro could soon reach $1.20.
“The EU continues to grow together and uses the opportunity to present itself as a unit to overtake the trading partner on the other side of the pond,” he said. “Crises are also opportunities. In the United States, crises are just crises.”
– Bloomberg.