Le centre peut-il tenir ?

Germany runs a current account surplus of 8 .2% of GDP while Europe overall is at 2 .6% of GDP. But does this represent a shining success? Not for investors in Europe. The major German companies, its great marquee names, trade at recession levels of four to five times P/E; its banks trade at 0 .2 price to book. This is hardly the stuff of legend.

The gulf between European valuations and their US counterparts remains high with Europe trading at a massive discount. Part of this lies with the composition of business – Europe has fewer technology firms and more privately owned companies. In fact, the most truly successful companies in Europe remain in private hands, and for good reason as they refuse to cave to short-term, quarterly earnings report-centred strategies.

The view from the outside is that Europe is a perennial basket case. This is an easy conclusion to reach if you don’t understand Europe’s history, its vested interests, the peace dividend and the need for government to sell the naive illusion of fiscal self-rule. The reality on that front, of course, is quite different. After all, where was Greece, Cyprus, Portugal, and Spain’s independence in the early 2010s? 

Within Saxo, we firmly believe that any macro change has to come from a breakdown or a crisis, and as  such we see 2019 and 2020 as key years for Europe’s evolution. We foresee populist parties getting 20% if not 25% of the popular vote in May’s European parliament elections… and that’s good news!

Why is it good news? Europe’s overarching goal has long been “more Europe” rather than “a better Europe”. After May, the new commission will play host to various populist platforms and voices who goal is for a more minimal Europe, and this will occur alongside a European Central Bank that is at a total loss in terms of new initiatives after a decade of ZIRP and no growth to show for it. 

The presence of a counter-trend is itself hopeful.The most important factor though is the collapse of German growth. We see a risk of recession there by Q4 even without a trade spat with the US. In a world moving quickly towards nationalism and anti-globalisation, the biggest loser will be the region that benefited the most from the big peace dividend of the Berlin Wall coming down: Europe, and Germany in particular.

Germany, with its (very successful) “industry 3 .0” model, is being left behind. Underinvestment in the technology sector leaves it unprepared as “industry 4 .0” rolls in, and its internet speed ranking (29 of 32 countries tracked by the OECD) is just one of many symptoms. Germany needs to catch up in terms of digitalisation, in terms of programmes for working women, with new airports and more overall infrastructure spending.

The lapse of Germany will reopen the Franco-German “hotline” as well as making the debt issue a pan-European issue, and not one of Germany versus the PIIGS, or austerity versus free spending. Germany grew too complacent, and so did the EU as a whole. Now the new reality has to see Berlin expand spending to be of benefit to the rest of Europe. Overall, a new common ground will be found from a more fragmented Europe.

Investors long convinced by talk of basket cases would be unwise to count out Europe. It is, after all, perfectly positioned to benefit from automation, AI, digitalisation and a capital market that is cheap by any standard (and due to this precise narrative).

Q2 will see the noise increase; the “basket case” narrative will be spread far and wide and the EUR, led by the ECB, will probably test 1 .05 if not 1 .03 versus the dollar. The next 12 months, however, will be 2000 all over again. 

In early 2000, I wrote myself a little note: “if EURUSD trades down to 0 .90, buy, buy, buy”. I am pulling out my yellow pad again now: if EUR trades below 1 .03, buy both it and the Stoxx 600 index because while Europe may have problems, it still has the most important component of productivity: the best public education system in the world.

Let’s hope I am proven right.