September in the Northern Hemisphere tends to be the beginning of the new school year. This year there seems to be a large amount on the ‘curriculum’.
Starting with Brexit, the temperature is rising as negotiations progress, given that the UK’s starting position of having cake and eating it (an analogy expressed by Boris Johnson, the UK Foreign Minister) is incompatible with a sharing community. Anyone who has had experience with a manufacturing business understands that supply chains are complex and highly integrated. In the 15 months since the vote, most of the pro-Leave camp have retreated from a ‘hard Brexit’ position on the simple realisation that it will be very damaging to the UK economy and its citizens. The sunlit uplands promised by the Vote Leave campaign do not actually exist and the Conservative party looks ill-equipped to sort out the mess easily. But more important is whether the UK, as a united nation, will be able to. This will dominate the UK’s ‘return to school’.
Has Europe learned its lesson?
The German Federal Election on 24 September to elect the members of the 19th Bundestag is likely to see Chancellor Merkel’s coalition return in some form or other. With elections in France, Hungary and the Netherlands earlier this year seeing a broad rejection of the alt-right anti-EU movement that has dominated recent media coverage, Europe’s leaders should – at last – have some breathing space. Much of the criticism levelled at the EU in the lead-up to the UK’s Brexit vote was, in our view, justified, and some of these issues are now being openly discussed. Turkey, for example, came up in the live televised German election debate between Merkel and her Social Democrat rival Martin Schulz, with Merkel taking the unexpected step of promising that she would try to end discussions over Turkey’s EU accession. There are plenty of other matters on the agenda, and it will be important to see how France and Germany can work more closely together in future.
In France, President Macron has pushed forward with extensive reforms designed to make the labour market more flexible, and thereby spur economic growth. As usual in France, there will be howls of protest, but this time there is a feeling that reforms are overdue. Macron’s policy of fast-tracking regulatory change through parliament is controversial, but with a gruelling schedule of meetings designed to build in concessions for the major stakeholders (unions and business leaders) without creating obstacles, he seems likely to overcome any protests.
Italy has been quiet and will probably be the next political hurdle at some stage over the next few months. However, the direction of travel is much clearer today than it was a year ago. Europe is not unravelling as wanted by the likes of Nigel Farage in the UK, Geert Wilders in the Netherlands, or US President Donald Trump (a vocal supporter of Brexit).
Euro strength overshadows Europe’s recovery
Given the strength of the economic recovery across Europe, it is no surprise to see a small amount of strength in the euro against the US dollar, but this arguably went too far when the currency reached $1.20 (on 28 August 2017). German 10 year bunds (government bonds) have seen yields move away from the negative levels of a year ago, thankfully. I believe the strong euro will undoubtedly become a headwind for earnings however, and there has been a trend of analyst downgrades over the last few weeks for those companies that make a significant proportion of their earnings in US dollars. European earnings growth on average may plateau at about 10–12% in 2017 after all, with 2018 struggling to reach similar levels. But it is worth putting these figures in context. Europe has struggled in previous years to generate the earnings growth that many expected. It seems to have gained traction in 2017, and there are many sectors, not least financials, where the earnings bounce back may remain strong into 2018.
While European markets have performed very well for sterling investors, in local currency terms Europe’s leading markets have risen by less than 5% in most cases so far this year (to 31 August 2017). That seems a rather begrudging response to political stability (outside the UK) and a return to economic and earnings growth, so I suspect that there is still scope for good performance from European equities over the next year.