Eurozone Investing - Cautious Optimism

Things are looking up for the eurozone economy, no doubt aided by market-friendly election results, particularly in France with the victory of pro-euro and pro-reform Emmanuel Macron over populist Marine le Pen. Unemployment has been falling steadily, from a high of 12.1% in March 2013 to 9.3% in May, and consumer confidence is at its highest since 2001. Inflation, at 1.3%, may still be somewhat below the European Central Bank’s (ECB) ‘close to but below 2%’ target but according to ECB president Mario Draghi it believes the forces currently weighing on eurozone inflation are temporary, and the bank may even be able to reduce its monetary stimulus before too long.

How should investment managers react to this? We would suggest that whilst optimism isn’t out of place, such optimism should be tempered by caution. Just as it’s important not to despair when those around you are panicking, so too is it important to realise that the glare of the economic silver lining potentially hides at least one cloud. And from an investment standpoint, just one of these wrinkles is the fact that study after study has highlighted that economic performance isn’t a reliable predictor of investment returns, even over the long-term.

To back this up, I turn to the 2017 edition of the Credit Suisse Global Investment Returns Yearbook, which compares various asset class returns over the last 117 years for the 21 countries with continuous investment histories.

Looking at equity performance in USD terms for those 21 countries over the period 1900-2016, one might have expected US equities to have performed the best. The 20th century was, after all, the “American Century” when the US emerged almost unscathed from two world wars to become the world’s sole economic superpower. Surely if economic performance translated into investment returns, the US should top the list? However, it did not. Whilst its long-term returns were impressive, at inflation plus 6.4% p.a., it was only third on the list.

At number two was Australia, perhaps not too surprising given its nickname “the lucky country”, but top of the list was South Africa with an annualised return of inflation plus 7.2% p.a. Over the past 117 years, South Africa has not been a shining example of economic prosperity. Despite a remarkable peaceful transition to democracy in 1994, over the period 1900-2016 it experienced long periods of political uncertainty, international sanctions during much of the apartheid era and recently fears that it was sliding towards a similar fate to Zimbabwe. At present, it is in the midst of a technical recession and has an unemployment rate of 27.7%.

And where did Japan, until fairly recently the world’s second biggest economy and a beneficiary of explosive economic growth in the 20th century, rank in terms of inflation adjusted returns? It was 14th, out of 21 countries.

So, by all means we should be pleased that, finally, the green shoots of recovery are appearing in EU economies. We should also take advantage of the rich investment opportunities available in mainland Europe. But investing is a complicated business and we should never assume that economic prosperity guarantees good investment returns, nor should we overlook opportunities in countries or regions going through difficult conditions.

This article first appeared in the August edition of The Trade Press publication.