The ECB took additional steps yesterday to address economic downside risks following the recent escalation in trade tensions. A reformed targeted lending facility will provide credit to banks that lend to companies, with rates from 10 basis points to as low as minus 30bps. The central bank also indicated that no rate rises were now likely until June 2020. The measures are an encouraging sign of the ECB's willingness to support growth.
But we still believe that the Eurozone economy will remain under pressure, and that Eurozone stocks are less attractive than their US counterparts.
- While the ECB has shown that it still has ammunition to combat economic weakness, it has far less in its arsenal than the Federal Reserve – with interest rates at 2.5% in the US versus -0.4% in the Eurozone. Although we don't see the Fed cutting rates as far as the market expects – 100bps by the end of 2020 – they do have more flexibility to cut if economic circumstances require it.
- The growth rate for the Eurozone is set to be significantly lower than that of the US for the remainder of 2019. The Eurozone is more vulnerable to weaker global demand. The region is biased in favor of trade in investment goods, European manufacturing has a heavy weighting to investment goods, and global investment is weakening in the environment of uncertainty over trade. As a result, the Eurozone stock market typically only outperforms the US in periods when global demand is strong. At present, however, the new orders component of the composite global Purchasing Managers' Index is at just 52 – barely above the 50 level that separates business expansion from contraction – and has been trending lower. Acknowledging the reduced chances of an economic rebound, the European Central Bank this week downgraded its growth forecasts and pushed out its forward guidance on when it would raise rates by two quarters to June 2020.
- Eurozone stocks aren't cheap either, at 13.6x 12-month forward PE, versus our fair value estimate of 12x.
Within international developed market stocks, we recommend an underweight to Eurozone equities, where market gains have outpaced economic fundamentals.
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