Europe’s clear & present danger

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Neil Woodford 5 June 2014 Est. reading: 2 min read

Is the Eurozone economy recovering?

On the day that Mario Draghi, President of the European Central Bank (ECB), has announced a further loosening of monetary policy by cutting its deposit rate below zero, we thought it would be worth tackling this question on the outlook for the Eurozone economy.

The mere fact that the ECB has taken such dramatic action today suggests that not all is well in the eurozone ­­­– and I agree.

We live in an extraordinary financial policy world, where the market eagerly anticipates the idea of negative interest rates without really thinking at all about the underlying problems that make such an extraordinary policy necessary.

In my view, the market is in denial about the real plight of the eurozone economy. In less than two years, since Draghi’s original “whatever it takes” speech in July 2012, the market has swung from despair to elation about the region’s prospects. Although some economic fundamentals have improved a little since, the most significant change has simply been sentiment.

The illustration below compares the level of some European market indices and bond yields on the eve of Draghi’s speech (25 July 2012) and now (4 June 2014) to illustrate the extent of this mood swing.

Source: Bloomberg

In fact, some economic indicators have markedly deteriorated. Deflation is a clear and present danger in Europe – Portugal and Greece already have negative inflation rates, Italy and Ireland are perilously close. Meanwhile, the dramatic rise of the far right evident in last month’s European elections is the political equivalent of a ‘nul points’ vote in the Eurovision Song Contest. European voters are clearly disillusioned by the policy of “More Europe” being pursued by the political elite and their mandate for pursuing this policy has substantially diminished.

I do not believe the eurozone economy is recovering – and it certainly isn’t recovering in a sustainable way.

The region continues to face major economic, social and political challenges. I’m not suggesting the market needs to plunge to the lows of 2012 but I do believe that the consensus has become far too complacent about the challenges. I am not complacent and I will bear these challenges in mind.

I remain optimistic about the prospects for certain stocks ­– there are plenty of companies that do not need a buoyant European economy in order to thrive. Those that do need it, however, already appear to be priced for its inevitable arrival and I am very wary of the risks involved in that very crowded trade.


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