Europe has dominated the risk landscape over the last five years. The region swung from one crisis to another as countries teetered on the brink of default, bond spreads between peripheral and core countries widened to record highs and speculation of a eurozone break up mounted. Markets disconnected from fundamentals and embarked on a roller-coaster ride determined by political rather than economic developments.
Just over a year since Mario Draghi’s pivotal “whatever it takes” speech, the economic situation looks less gloomy and investors, buoyed by returning confidence in the value of the euro, are less easily spooked by on-going political uncertainty and the threat of further peripheral bailouts.
“A lot of investors have been far too worried about the eurozone,” says Colin McLean, managing director at SVM Asset Management.
“The idea the region might bumble along towards recovery has not been factored in, which has left people underinvested. Now that it looks like Europe will bumble through, the lower sensitivity of investors to political issues is not misplaced.”
Official figures released in August showed Europe finally emerging from 18 months of recession. Growth, despite being a modest 0.3%, was greater than expected. Investors’ confidence in the region picked up and money began to flow back into European equities. Western European equity funds tracked by EPFR Global saw $10bn inflows between the end of July and 1 September. By the 18th, year to date returns were up 14.22%.
Despite many issues underpinning the European crisis remaining unresolved and with more bailouts necessary, bond spreads have returned to more normal levels. Pre-crisis eurozone bond yields generally moved in line with each other, a relationship that broke when the crisis hit. 2011 and 2012 saw the spreads on Italian and Spanish 10-year government bonds versus benchmark German Bunds widen to record levels as concerns of default in core countries mounted and investors flooded into safe-haven assets.
Although yields on Italian and Spanish bonds remain well above Bunds, they have returned to more normal pre-crisis levels. French, German and UK benchmark government bond yields remain at near record lows, but normalisation has begun with yields increasing 0.5%, 0.5% and 1.35% respectively since April, according to data from Thomson Reuters.
Yet the political and economic landscape remains shaky, not just in Italy and Spain, but across the region as a whole. As Stuart Robertson, senior economist at Aviva Investors, says: “There is still a lot of pain to go through in places like Spain, growth in Q3 will not be as good as Q2 and there is a chance of postelection Germany trying to make Europe more German, which could be tough on peripheral countries.
“We are seeing a return to fundamentally driven markets though,” Robertson says. “The political drama in Italy has had little effect on markets and sentiment doesn’t have as much influence as a year ago, which has to be a good thing.”
For now at least, markets appear to be feeling more confident about the prospects for Europe, which is good news for investors as equity prices begin to rise, doubts over the future of the euro abate and assets once again trade on their economic fundamentals.
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