The European Central Bank (ECB) decided on July 20th to maintain its extraordinary monetary stimulus with no change in policy interest rates. ECB President Mario Draghi’s remarks reassured markets that the eventual move towards normalization of rates and the ECB’s balance sheet will not be made prematurely. While the Eurozone recovery is looking robust, inflation dynamics have yet to become stronger. Also, the ECB probably would rather not add at this time to the upward movement of the euro. Our expectation is still that the ECB will normalize policy only slowly – and later than the US Federal Reserve does.
The strength of the Eurozone recovery thus far in 2017 has been impressive, leading economists to raise their projections for the year. Market and consumer sentiment is quite positive. Summarizing their Purchasing Managers Index data for June, Markit reported that the Eurozone growth outperformed that of other developed economies for the fifth straight month, and second-quarter growth was the strongest for over six years. Industrial production picked up significantly, and retail sales have improved. Eurozone GDP growth for the year now looks likely to reach 2.3%, significantly above many forecasts made earlier in the year. Concerns about Eurozone banks have eased somewhat as national and European authorities have moved to address problems. Forecasts that the euro would decline to par with the US dollar or lower have disappeared as the euro has risen about 10% year-to-date. Indeed, the main risk facing the Eurozone economy in the coming quarters is that the strong euro will have an adverse effect on trade growth.
On the political front, perceived political risk has declined. Markets have welcomed the very strong parliamentary election results for French president Macron and his pro-market economic reforms agenda, along with the continued political strength of Chancellor Merkel in Germany. These two very popular European heads of state are now seen as assuming a leadership role for defending not only the single European currency and the European Monetary Union but more broadly the post–World War II global trade and economic system as US President Trump asserts a populist nationalist position. The two largest Eurozone economies are both advancing strongly. Germany’s GDP looks likely to register an above-trend 2.3% growth this year, compared with its 1.8% advance in 2016, while France’s GDP may well record a 2.0% advance, almost double last year’s 1.1% growth.
Equity markets in the Eurozone have outperformed so far this year. While in the US the SPDR S&P 500 ETF, SPY, is up just 11.52% year-to-date as of July 19 and the iShares MSCI EAFE (Advanced markets ex-North America) ETF, EFA, is up 17.14%, the iShares MSCI Eurozone ETF has gained 21.6% on a total return basis, as calculated by Ned Davis Research. The iShares MSCI Germany ETF, EWG, is up 18.66, and other Eurozone country ETFs have been even stronger. The iShares MSCI France ETF, EWQ, has gained 21.52%; iShares MSCI Italy ETF, EWI, 22.51%; iShares MSCI Netherlands ETF, EWN, 26.04%; iShares MSCI Spain ETF, EWP, 27.31%; and iShares MSCI Austria, EWO, an outstanding 35.84%. These markets are still momentum leaders. We would consider market drawbacks as possible opportunities to add to positions.