European equities are likely to continue to lead the stock markets higher into the end of the first quarter, but there will be some hiccups.
The technical picture looks good, but the question is whether technical factors and the aggressively interventionist monetary policy will be enough to put an end to the eurozone crisis for good.
The European Central Bank’s decision to start buying sovereign bonds has marked a decisive moment and is the main reason behind European stocks’ advance, with positive earnings revisions expected to cheer up investors.
The Stoxx 600 index of large and mid-caps in 18 European countries is up 18% year to date in euro terms.
Last week, the index gained another 2%, with prior week’s laggards, such as utilities, resources and energy, taking the lead.
Chris Tinker, co-founder at Libra Investment Services, said that the “extremely low levels of sector correlation seen in Europe” mean that this type of “tracking error catch-up” is likely to continue to feature in the last week of this quarter.
The strength of the recovery of European fair value is in sharp contrast both to its own history and that of the US, Tinker wrote in a recent note for the markets.
“We are back to the pace of April 2012 when the Fed’s QE2 (second round of quantitative easing) was in full swing and the ECB’s first reforms and funding programmes were in place,” he said.
“The pace of recovery in value is unlikely to be sustained at these levels, so we remain wary of chasing this situation too far, but it does underline the relative growth still available across many European sectors.”
Among the good news for the eurozone is the fact that Portugal has started to repay its debt to the International Monetary Fund (IMF) early.
It paid back 6.6 billion euros, or around 22% of the total, last week due to record-low bond yields, which allowed it to borrow cheaply on the international markets.
Portugal’s debt to the IMF carries an interest rate of around 3.5% while the country issued 10-year bonds at just over 2% last month. Since then, the yield has fallen to about 1.7%, after the ECB launched its quantitative easing programme.
Portugal’s economy seems to be doing well. The country’s GDP expanded by 0.5% in the last quarter of 2015, the seventh expansion in eight quarters, while unemployment fell to 13.3% in January after it had peaked at 17.5%.
The government expects the budget deficit to fall to below the 3% of GDP ceiling set by EU rules for the first time since 1989, Jennifer McKeown, senior European economist at Capital Economics, said.
But, she added, there are several factors restraining the country’s growth. The ability of banks to lend to businesses is one of them.
Debt in the private sector in Portugal, especially in the corporate sector, remains very high, McKeown said. Gross debt to GDP was 128% at the end of last year and Capital Economics forecasts that it will grow to around 140% by next year.
“And with non-performing loans at 12.9% of the total and rising, it is not surprising that bank lending has continued to fall. Both factors will restrain business investment in future,” she warned.
Despite the rise of extremist politicians, Europe’s political and social environment has been surprisingly benign for the depth of the crisis the continent has endured for the past five years.
Negotiations with Greece’s Prime Minister Alexis Tsipras, the leader of left-wing Syriza, seem to be going towards the country’s continuing tough reforms, as the Greek leader begins to realise he has a stark choice between reforms and leaving the eurozone and even, ultimately, the European Union.
In Spain, the anti-austerity party Podemos did less well than expected in regional elections in Andalusia, coming in third.
In France, the extremist Front National led by Marine LePen came second in departmental elections, with a little over 25%, despite polls suggesting it would get about 30% of the votes.
As ECB QE and the weaker euro start to have an impact on exports and slowly push down unemployment, Europe may have just skirted political risk, in the opinion of Alberto Gallo, head of European macro credit research at RBS.
But “the risk is that, however, with lower yields at home, European politicians may be more complacent – about reforms in the periphery, and about minimising the risks of an exit in core Europe.”