By Wasif Latif
Vice President, Global Multi-Assets
Headlines and data are hardly cheery – Germany’s all-important economy has offered little in the way of good news lately, France and Italy both are caught up in political identity crises, and the only accurate description of Brexit is that “it’s complicated.”
Looking further out, however, there are reasons to be confident that the struggling region can deliver worthwhile equity performance. Much of that confidence is based on what we see as overly pessimistic valuations and our belief that European shares still have more upside based on history and the economic cycle.
Much of the trouble that Europe faces can be traced back to the U.S.-China trade dispute that has been playing out over the past year. While China has been the primary target of the White House’s protectionist moves, the European Union’s export-oriented economies are also affected.
Germany, historically the region’s powerful growth engine, is teetering on the edge of recession as U.S. tariffs are biting into German steel exports – the nation’s GDP growth rate in 2018 was second from last in the eurozone. The effect of U.S. tariffs and other measures on China is also being felt by Germany’s luxury car makers, whose profitability has grown increasingly dependent on the Chinese market.
Any trade tensions between the U.S. and the EU are now getting second-billing, but they could take on more of the harsh rhetoric being heard in the U.S.-China dispute.
Much of the Trump administration’s agitation with China is focused on its trade surplus with the U.S. – in 2018, the EU posted a record trade surplus with the U.S. of roughly $150 billion. In dollar terms, that number is less than half of the U.S.-China trade imbalance, but still large enough to potentially put the EU in Washington’s crosshairs. This risk to the EU likely grows if or when the U.S. and China find a way to settle their standoff.
None of the major issues facing Europe are particularly new, so in our view they are largely baked into current share prices. Also baked in is the likelihood that the slow pace of economic growth in Germany and elsewhere will force the European Central Bank to temper its plans to start tightening the money supply.
These factors have created an opportunity for value-oriented investors who judge companies based on their fundamentals – so far in 2019, European stocks are up about 8.25% according to the MSCI Europe Index. That figure lags the S&P 500’s 11% gain through last Friday, but it is nonetheless respectable. If economic and/or political conditions improve in Europe, or if the current low expectations turn out to be too pessimistic, shares could benefit further.
USAA’s asset allocation funds maintain a market overweight to Europe, with the lion’s share of that overweight in the strategic allocation that takes a long-term view based on relative valuations. In addition to trade and political considerations, we believe Europe is earlier in its economic cycle than the U.S. – essentially, this means we think it has a longer growth period ahead, which stands to be a positive for companies and thus share prices.
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