Don’t Forget the investment opportunities from Brexit

Many UK investors are looking towards European stocks in the hope that there’s been a fundamental shift in the region’s prospects. After all we are Europe’s closest neighbour and with Brexit (yes, do we still even remember that) now in full swing, the changing dynamics between Europe and the UK will undoubtedly give rise to great investment opportunities.

However part of the problem has been that “Europe” has too often represented a disparate mix of growth stories and basket cases. Germany has tended to have a solid fiscal position, while being underinvested in public infrastructure. Meanwhile, fiscal constraints have hampered Italian efforts to clean up and recapitalise their banks. For so long, the question for Europe has been whether the politics and institutional framework of the region could finally work together for greater good.

Back in 2012, European Central Bank chief Mario Draghi declared he would do “whatever it takes” to save the eurozone from collapsing under the weight of the region’s mounting debt crisis. And at various times since then, the ECB has talked and acted tough about how it would stimulate the region’s economy. More than EUR1trn was spent on a quantitative easing program focused on stirring regional growth and spurring inflationary pressures. Yet the scheme had limited success.

Even cutting interest rates to take the deposit rate into negative territory, forcing banks to pump more money into the region's financial system, failed to have the required impact.

Europe has limped from one crisis to the next in recent years. The policy response of quantitative easing and negative interest rates was a similar approach to Japan. But like in Japan, there has been a concern that the central bank may have reached the limit of its ability to stimulate.

Eurozone GDP Change from Prior Quarter (% seasonally adjusted)

The US-China trade war and the imposition of tariffs on imports weighed heavily on growth in 2019, and on forecasts. That, alongside political uncertainty in its largest economy Germany, divisions over the EU budget and Brexit, were all factors for the regional economy to contend with. Then COVID-19 happened.
COVID-19 has worsened the situation
    The outbreak of the coronavirus is certain to dent growth forecasts in the region further. The EU is bracing itself for a “recession of historic proportions” this year, with the coronavirus pandemic expected to cause a 7.4% drop in economic output. “Europe is experiencing an economic shock without precedent since the Great Depression,” the EU’s economy chief Paolo Gentiloni said. He warned the sharp downturn poses a threat to the EU’s single currency and the single market.

Markets heavily reliant on tourism are expected to see some of the most weakness. Greece, Italy, Spain and Croatia are all set to see their economies shrink by more than 9% in 2020. But even Europe’s economic powerhouse Germany is set to see its GDP contract by 6.5%.

Regional economies may started to reopen but the damage has been done. The pandemic has hurt consumer spending, industrial output, investment, international trade, capital flows and supply chains. It has also thrown millions of people out of their jobs. The unemployment rate across the EU is forecast to rise from 6.7% in 2019 to 9% in 2020 but then fall to around 8% in 2021, according to the Commission. It cautions, however, that its outlook is highly uncertain, with long-term damage to the labour market.

Euro Area Manufacturing PMI Slowly Recovering from COVID-19

Possible signs of hope
  Despite the backdrop, there could be reasons for optimism. Broad-brushed strategies to drive growth have failed in recent years. However, suggested new stimulus measures are likely to be “micro-targeted” toward specific sectors, which could be what the region needs.

The EU has already agreed a new EUR750bn recovery plan, which could be is a crucial turning point for Europe’s economy and financial markets. Although member states are currently battling over the structure of a longer-term fund which could potentially add up to EUR1.5trn to the recovery effort, there appears to be more commitment at government level.

Within this plan is the Green Deal. This is the EU’s “new growth strategy,” Commission President Ursula von der Leyen told the European Parliament in her maiden speech, as she put the EU on an ambitious quest to become “the first climate neutral continent in the world by 2050”.

Although the deal remains in its infancy, the challenges of climate change and COIVD-19 might actually drive the evolution of green investment. This might turn out to be the structural growth opportunity that Europe has needed.