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Published: 1st June 2020 (5 Min Read)

Maybe, maybe not, but might it be time to buy European equities?

Since I returned to the UK over twenty years ago after working in Munich it has been a regular source of frustration to me that the majority of Anglo-Saxon commentators constantly take themselves into their echo chambers on the subject of impending EU demise.

They have consistently laid this out as a near certainty and, as we know, they have been consistently wrong.

Each time I have tried to explain that they might have been wrong, but without the confidence necessary to express a high degree of certainty because being an Anglo-Saxon myself I understand their reasoning.

I have some sympathy with their views because I believe that a monetary union is not viable without a form of fiscal union, and there hasn’t been one. A fiscal union requires the transfer of money from the stronger to the weaker members. A fiscal union need not be a political union, but it requires shared policies and generosity.

My sympathy with my fellow Brits ends however when the subject extends beyond monetary union.

On this side of the Channel many people have repeatedly failed to recognise fully three important general points.

First, the impact of two world wars, a cold war and a number of civil wars within less than a hundred years upon the citizens of the same continental land mass. As populations age the strength of feeling derived from this shared history ebbs but remains important for many. It is considered better to disagree amongst themselves, and to muddle through, rather than to go their separate ways.

Unless one has lived in central Europe it is difficult to understand how irrelevant borders can seem when invisible, and yet how psychologically imposing they can be when they are not.

Second, our continental neighbours tend to be social democracies, which are more accepting of State intervention than the UK or the US which are more closely aligned with each other in their adherence to free market forces. It is true that the paternalism of an unelected supra-national body is different to that of a State, but it is more alien still to the Anglo-Saxon systems.

Finally, the UK’s first past the post electoral system causes issues to be perceived as black or white. In many parts of Europe coalition governments are either the norm or not unusual, and thus debate is often more nuanced because compromise has frequently to be found. This is how the EU works too. It is about collaboration and cooperation. It takes time. It is not good for headlines.

This is a classic example of the difference between “thinking fast and slow”. The commentators respond quickly, while the policymakers seem to bide their time.

More recently the German Constitutional Court (GCC) ruled against actions of the European Central Bank (ECB). Academic lawyers argue about whether the GCC has oversight of the ECB or precedence over the European Court of Justice (ECJ), but I do not wish to examine those issues here. The resolution is a political issue. [i]

The GCC ruling caused general malaise about whether the ECB would be able to continue its purchases of European sovereign debt, and this caused the usual response of “the EU is about to fall apart”. It was difficult to find positive straws in the wind.

Then the Franco-German duo of Merkel and Macron announced the 500 billion euro EU Recovery Fund. This looked like a step in the right direction, but even the generally Europhile Chatham House felt it did not go far enough[ii].

It also failed to have the full backing of the more fiscally conservative “Frugal Four” nations.[iii]

On the other hand, some argue that it may demonstrate a decisive step towards fiscal coordination[iv], and that it crosses historical red lines.

Since then the European Commission has proposed a 750 billion euro fund. The “Next Generation EU” fund requires the unanimous backing of all EU members. It will take time to negotiate, but it is proposed alongside a re-vamped longer-term EU budget which together would total 1.85 trillion euros.[v]

The proposal puts “The European Green Deal”, announced last year and which aims for the EU to be carbon neutral by 2050, at its core. The “Green Deal” foresaw the spending of 1 trillion euros of investment in climate action and environmental sustainability by 2030.[vi]

It is expected that about 500 billion euros would come from the aforementioned budget and about 100 billion from the “just transition” mechanism within “Next Generation EU”. National budgets would contribute an additional 100 billion or so, and the private sector the balance of nearly 300 billion euros. The European Investment Bank would provide loan guarantees to the private sector.[vii]

Undoubtedly there is double-counting among these numbers, but if anything close to these proposals is agreed then it would be positive for growth in Europe, for the EU and the Eurozone, for the asset purchasing activities of the ECB, for investment in a more “green” future, and for the leadership of European companies in environmentally focused activities. It would be a fiscal union.

So, worth buying European equities? Maybe, but the indices contain too many “old industries”. Investment in “global corporate leaders” which happen to be domiciled in Europe? Very probably, but many of these have recovered along with other globally leading companies, so only for the long term. It is also worth noting that many of the global funds which invest for a “sustainable future” typically have more investments in Europe than those which do not.

Do I feel any more confident about achieving this positive outcome than I did on previous occasions? No, but I do suspect that once again we Brits are underestimating our continental cousins.

Sources
[i] https://www.bruegel.org/2020/05/the-european-central-bank-in-the-covid-19-crisis-whatever-it-takes-within-its-mandate/
[ii] https://www.chathamhouse.org/expert/comment/franco-german-recovery-fund-will-not-fix-eurozone
[iii] https://www.ft.com/content/22f0ab8b-0884-4fb0-a5be-d99193d236bf
[iv] https://www.project-syndicate.org/commentary/france-germany-covid19-recovery-fund-eu-by-lucrezia-reichlin-2020-05?utm_source=Project+Syndicate+Newsletter&utm_campaign=e3f757dd5a-sunday_newsletter_31_05_2020&utm_medium=email&utm_term=0_73bad5b7d8-e3f757dd5a-106855607&mc_cid=e3f757dd5a&mc_eid=fdc25f7e01
[v] https://www.reuters.com/article/eu-budget-recovery-proposals/eu-executive-proposes-1-85-trillion-euros-of-coronavirus-recovery-plan-idUSB5N28S00W
[vi] https://fbkfinanzwirtschaft.wordpress.com/2019/11/28/the-power-of-green-public-finance/
[vii] https://www.theguardian.com/world/2020/mar/09/what-is-the-european-green-deal-and-will-it-really-cost-1tn
Article written by
Simon James