Market Commentary - 3.3.15

Europe: Third Time's a Charm?

Year-to-date, European stocks have outperformed U.S. equities by a significant margin. This outperformance has led investors to wonder, after years of false starts, whether or not the Eurozone has finally turned the corner. Despite some concerns about Ukraine and a potential Greek exit from the Eurozone, and given the pledge by the European Central Bank (ECB) to stimulate the region and the overall improvement in economic data, we believe a case can be made that the Eurozone is on the right track.

Following the Great Recession, the performance of European equities has generally been mixed due to uncertainty stemming from weak economic data and concerns about secular stagnation, lack of a united effort to improve these poor fundamentals, an uncertain future of the overall Eurozone, and increased geopolitical risks. However, this year through March 2nd, the MSCI Europe Index (+5.82%) has outperformed the Russell 3000 (+3.50%). Investors have aggressively bought European equities twice in the recent past - in mid-2012 after ECB President Mario Draghi pledged to defend the Euro and in mid-2013 when the Eurozone economy showed some improvement - hoping for a turnaround that did not unfold, but what makes this time different is that the ECB's policy actions and improving economic data appear to be aligned with investors' interests.

Last August, Draghi hinted that European Quantitative Easing (QE) would be implemented in the near future. This was an important milestone because investors were anticipating that European QE would provide a similar economic boost and confidence build that occurred when the Fed implemented QE in the U.S. Since the ECB's Governing Council voted on January 22nd to implement QE, European equities have done well.

In addition to policy changes around QE, there has been a marked improvement in European economic data. Some highlights include the following:

  • Sales - German retail sales increased by 2.9% in January, the strongest monthly increase in seven years.
  • Manufacturing - The Purchasing Managers Index held steady at 51.0 in February, remaining above the 50 threshold that denotes growth.
  • Exports - New export orders rose at the fastest pace since July last year, suggesting a weaker Euro (a byproduct of the QE implementation) is helping drive demand from outside the region.
  • Wages - Germany's largest union agreed to a 3.4% pay increase. The deal is seen as a bellwether for negotiations in the rest of the country and represents an increase greater than three times current inflation.
  • Lending - Overall bank lending has picked up in the region. This is likely due to the combination of improved economic activity and currently negative money market rates in the Eurozone that is causing investors to leave more money in banks, thereby providing more lendable funds available to banks.

In addition to improved economic data, there is also optimism around those Eurozone members that undertook painful austerity and structural reforms over the past few years. Many of these countries, such as Ireland, Portugal, and Spain, have turned the corner and are today among the fastest growing within the region.

Overall, we remain cautiously optimistic about the Eurozone region. On one hand, the combination of an investor-friendly ECB and improving economic readings are helping to drive returns in the region. On the other hand, considering the lingering economic devastation from the Great Recession, anxieties about a Greek exit, and rising geopolitical concerns (such as Ukraine), the still delicate and fragile Eurozone needs to make even more advances before we would be extremely bullish on the region. With that said, we continue to stress diversification in portfolios, including an allocation to international investments. Moreover, given our cautious optimism about Europe, within an international allocation, we would slightly tilt toward this region.

This information is compiled by Cetera Investment Management.

About Cetera Investment Management
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