Investment View Q4 2014

The summer period in Europe was dreadful, not only from a meteorological point of view.

June and July European stock markets dropped sharply by about 10%, although some European markets recouped most of their losses in August and September. The picture developing in the first days of October does not bode well, however. In fact, stock markets of the largest European economies, Germany, France and the UK, are all down for the year.

The decline in German PMI numbers for September and the surprising fall of German production numbers in August are the latest sign that the outlook for Europe’s largest economy is deteriorating. Production dropped 4 percent from July, when it expanded 1.6 percent. That is the biggest decline since January 2009. Germany’s economy is losing steam as sluggish growth in the Eurozone, its largest export market, and the impact of trade sanctions against and by Russia weigh on confidence. This doesn’t bode well for the final quarter of this year. According to Spiegel magazine, the IMF will cut its German growth forecast for next year to about 1.5 percent from 1.9 percent.

The European Central Bank’s first offering of cheap, four-year loans, a program also known as TLTRO (targeted longer-term refinancing operations), to Eurozone banks failed to generate as much interest as expected, raising pressure on the ECB to find other ways of stimulating the region’s weak economy and boosting inflation from its worrisomely low levels as well as employment.

Unemployment stands at 11.5%, far above rates in the U.S., U.K. and Japan.

The hope is that this program would stimulate demand for goods and services and, in turn, raise annual inflation. Too-low inflation makes it more difficult for governments and households to cut their high debt levels, a particular problem in southern Europe, where unemployment is very high. More worrying for policy makers is the threat of deflation—a sustained and self-reinforcing fall in prices—that weak inflation poses.

The sluggish demand for the loan program may also suggest that banks are waiting for the results of the stress tests(published end of October) before issuing new loans.

To find other ways of stimulating the region, the ECB has said it would start buying bundles of loans known as asset- backed securities and covered bonds next month, but it hasn’t set a target amount. This program, known as quantitative easing, is similar to the programs introduced by the Fed and the BoE.

The fact that Germany has agreed to this program is very significant. For many years German policy makers opposed the ECB to buy asset backed securities or government bonds.

It may also open the door to a single European Central Bank with a much wider mandate.

Mr Draghi is urging Eurozone governments not to deviate from the implementation of highly needed structural reforms. These reforms are unpopular, especially in Italy and France, though Spain has made some success.

France will again be missing its deficit target (3% of GDP) for 2015 and its finances seem to be out of control. French National debt now stands above 2,000Billion EUR at 96.9% of GDP.

For a brief moment headlines were focussed on the Scottish vote for or against staying in the Union. The face of the UK was saved by the Yes vote. A No vote would have given majority to the Tory party in British Parliament and an exit from the Eurozone by Britain could have been the result. For the Eurozone it means less pressure from other potential “get away” regions, like Catalonia.

The political situation in the Middle East has escalated. The Islamic State (IS) has become the joint enemy of many former enemies. The United States is now fighting IS with the support of Syria and Iran. Nobody knows when and how this conflict will end. For the time being, this conflict risks to spill over to Turkey and maybe even to Israel. Such a large scale conflict will not be ignored by consumers and companies, which may delay, or even stop, investment decisions.

Download the full report: Hoving & Partner Investment View Q4 2014