While global economic data has come in relatively weak thus far in 2015, one bright spot has been the Eurozone. The European Central Bank boosted its economic forecasts from three months ago, saying it now expects growth of 1.5% this year, 1.9% in 2016 and 2.0% in 2017. It had previously forecast growth of 1% in 2015 and 1.5% in 2016. Though this is not exactly runaway growth, it is encouraging. It shows that ECB policy action — monthly purchases of 60 billion euros in securities from March 2015 through September 2016 in order to spur inflation back to its target of below but close to 2% — is having a significant positive impact on the economy.
The theme of U.S. economic decoupling, which had been a key story in developed markets over the past few years, appears to be waning. In addition, we have seen a stabilization of Eurozone medium-term inflation expectations in recent months. Headline inflation turned positive in May after five months at or below zero. Retail sales and consumer and business confidence are showing some improvement as well. While the reader may be a bit exhausted by the relentless and myopic focus of economic commentary on monetary policy divergence, the ECB’s policies work in our favor on this position.
While U.S. stocks appear fully valued, this stands in contrast to the relatively cheaper valuation for European equities. Additionally, the U.S. economy appears to be further advanced in the business cycle than Europe (perhaps mid-cycle versus early-cycle), and equities typically perform better in the early part of the cycle.
Our view on Europe has become the consensus view. That actually makes us a bit nervous, as we are inherently skeptical of groupthink. Accordingly, we have scaled our position to be modest in size, so as to not dominate the risk profile of our funds.
The Multi-Asset Solutions Team (MAST) has recently increased our position in European equities, funded out of U.S. equities. While European equities have outperformed U.S. equities since we instituted the position early this year, we feel there is further upside in this position.