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Europe: Will Political Risk or Economic Recovery Prevail?

By: Janus Capital Group
Harvest Exchange
March 23, 2017

Europe: Will Political Risk or Economic Recovery Prevail?

Europe: Will Political Risk or Economic Recovery Prevail?

Our outlook for Europe balances the pull of political concerns with the promise of an economic recovery because of a weaker currency and strong U.S. economy. We think Europe could outperform the U.S. market this year but it offers more risk.

First the risks: Europe faces elections in France and Germany this year plus the expected start to real Brexit negotiations. We don’t think the outcomes in either country will lead to a populist movement to end the euro or further weaken the EU. Yet political predictions, as we learned from Brexit, Donald Trump and Italy, are uncertain in this environment, and voter attitudes can shift sharply in the wake of a terrorist attack or another immigration crisis. Despite saber rattling on both sides ahead of the formal start to Brexit negotiations, we also expect the UK and the EU will remain rational and that neither will risk economically disruptive trade policies.

If the political situation doesn’t upset the cart, we think the market will rally on the back of better global growth. Moreover, we are starting with attractive valuations in Europe. We also think the U.S. will see strong economic growth this year, driving a stronger U.S. dollar. Our view implies a weaker euro and strong global demand to benefit exporters. We are also seeing the early signs of returning inflation, which will be a positive for equities.

Sectors tied to global demand, such as industrials, look attractive. Many companies and countries have used the global financial crisis, and the years since, to improve their operating efficiency and roll back costly labor rules respectively. As a result firms have good operating leverage to take advantage of stronger global demand. Even luxury companies, with strong USD sales, can benefit too. While there are unstable banks, clearly, the overall financial sector is poised to respond to better demand, higher inflation and therefore the anticipation of rising rates.

Export-oriented countries, such as Germany and Italy, can benefit. France could do well, too, if the shadow of major political upheaval fades. Greece also has a lot of leverage if better global conditions can revive and stabilize its struggling economy.

The outlook for Europe is tied to its own political trends, a weaker Euro, and to the U.S. growth picture. Should U.S. growth come in below expectations, perhaps because a soaring USD chokes American exports, Europe will be hurt too. We think the region can walk this tightrope, but it is not a certain path.

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Originally Published at: Europe: Will Political Risk or Economic Recovery Prevail?