Market Views: How do Asian investors view European assets as winter approaches?
As winter approaches Europe, recession fears have heightened amid the anticipated rise in energy consumption, record energy prices and the ongoing Russian invasion of Ukraine.
In addition, the number of investors betting that the euro will fall in value have reached their highest level since the pandemic hit Europe more than two years ago, according to the Financial Times.
Over the last year, the euro lost 15% of its value. Last week, it fell to its lowest level in 20 years - below parity with the dollar for the first time in two decades. That happened as wholesale gas and power prices in Europe soared to all-time highs due to concerns that Russia would stifle vital energy supplies.
Also read: Market Views: How does energy market turmoil provide investment opportunities?
At the annual gathering of central bankers in Jackson Hole last weekend, European Central Bank (ECB) executive board member Isabel Schnabel and François Villeroy de Galhau, the French central bank governor, warned that monetary policy will have to remain restrictive for an extended period in Europe to combat rising inflation and interest rates.
"Even if we enter a recession, we have basically little choice but to continue our policy path," Schnabel said. "If there were a deanchoring of inflation expectations, the effect on the economy would be even worse."
In light of the economic outlook for the Europe, we asked asset managers and analysts how they gauge the situation, and what kind of appetite Asia’s investors have displayed for euro assets with winter on the way.
The following contributions have been edited for clarity and brevity.
Sylvia Sheng, global multi-asset strategist
JP Morgan Asset Management
With a deepening gas crisis looming and the ECB on a tightening path, risks to the European economy are tilted to the downside. The outlook for the European gas situation is worrisome. With the Nord Stream pipeline operating at only 20% of its capacity in the past few months, gas markets in Europe are expected to stay tight. Should Russian gas flows not suffice, gas rationing seems inevitable to build gas storage for the winter months, which will likely hit industrial output and weigh on European growth.
We are expecting a prolonged period of sub-trend growth in Europe and see a particularly challenging growth-inflation tradeoff. We believe that the euro can devalue further versus the US dollar and have a small underweight to German bunds. Regarding the stock market, we are neutral on European stocks but underweight their global peers. While we have noted several risks to the European outlook, the market has significant valuation support. It is also relatively insulated from the de-rating dynamic that has hurt more highly valued stocks, such as US tech stocks, this year.
Mary Nicola, portfolio manager, global multi-asset
We have been underweight in the euro for quite some time as the currency has been struggling off the back of a more hawkish Fed, concerns of an energy crisis in the winter, and expectations of weaker growth that will coincide with the energy crisis. The threat of an energy crisis and stagflationary pressures will continue to be challenges for the foreseeable future.
In addition, we maintain a very cautious stance on European assets in general as the Eurozone continues to bear the brunt of the Ukraine-Russia crisis, the ECB navigates the balancing act of inflation and growth, and political uncertainty in Italy weighs down on both the currency and regional assets.
With this in mind, within equities, we have allocated our risk budget to US Quality – an allocation that is focused on companies with strong balance sheets able to withstand the environment ahead. We are also underweight euro versus the US dollar considering the challenges mentioned above.
Daniel Morris, chief market strategist
BNP Paribas Asset Management
The euro has weakened sharply this year as investors worry about the economic outlook, particularly in light of the risk of a shut-off in Russian gas supplies this winter. The weakness is all the more notable as market expectations for the level of policy rates in the eurozone have been rising by more than they have in the US.
The cloudy economic outlook has already weighed on the performance of eurozone UK equities, which have underperformed global equities by about 4 percentage points. As a result, valuations appear attractive based on forward price/earnings multiples, but that assumes one has confidence in the earnings estimates. Given that forecasts are for 9% earnings growth next year, we are sceptical.
For BNP Paribas Asset Management, we remain underweight Europe ex-UK equities. There may potentially be more opportunity within eurozone investment grade credit. Spreads have widened meaningfully, and we believe at these levels they more than compensate investors for the risk they are taking. Current spreads imply exaggerated defaults when balance sheets are in fact solid. As for government bonds, we see current levels as reasonable and do not anticipate strong moves in either direction from here.
Chang Hwan Sung, portfolio manager
Invesco Investment Solutions
With the ongoing energy crisis and fears of inflation and recession, the global economy continues to deteriorate led by noticeable declines in the US and the Eurozone. Coupled with decelerating global risk appetite, our macro regime framework has now moved to a contraction regime, noting the continued weak trend in leading economic indicators for developed economies.
Within equities we have moved from overweight European equities relative to the US to neutral, as early signs of cyclical divergence dissipated. We maintain an underweight exposure to value, small and mid-cap equities, favoring defensive factors like quality and low volatility, and add momentum exposure, which tends to add defensive characteristics and downside protection during protracted downturns in the market. We continue to be constructive on defensive sector exposures such as information technology, communication services and health care, at the expense of financials, industrials, and materials.
In currency markets, we maintain a neutral exposure to the US dollar at this stage and now favor the euro, British pound, Norwegian kroner and Swedish krona relative to the Swiss Franc, Japanese yen, Australian and Canadian dollars. Tighter US monetary policy and weakening global growth relative to consensus expectations provide support to the greenback, but valuations headwinds suggest better entry levels.