Brexit is Least of Europe's Concerns say Stock Pickers

Brexit could shave 0.3% off European economic growth. But bigger potential pitfalls include upcoming elections, interest rates and Italy's bank balance

Holly Black 18 January, 2019 | 7:26AM

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Brexit might be top of the political agenda in the UK, but across the Channel, Europe has been focused on homegrown concerns. But David Zahn, head of European fixed income at Franklin Templeton, says while the UK is likely to bear the brunt of the impact of Brexit, it is also likely to affect the EU.

Zahn estimates that growth in Europe could be hit by up to 0.3% in the event of a hard Brexit. He adds: “That may not seem much, but when the EU is only growing at 1.5% to 2% it represents a more sizeable chunk.”

Cause for Concern

And Brexit is not the only cloud on the Continental horizon. Germany has recorded is worst economic growth rate for five years, with GDP for 2018 at just 1.5%, meanwhile there are ongoing concerns about the Italian budget, and uncertainty about when the European Central Bank will start to raise interest rates.

In December, ECB president Mario Draghi, warned that economic growth in the Eurozone would be limited to 1.7% this year as quantitative easing came to an end.

Other potential political upsets include the Greek, Finnish and Portugese elections as well as a collapse of popularity in French President Emmanuel Macron after recent protests.

Azad Zangana, senior European economist at Schroders, thinks tightening liquidity is a major concern for the year ahead. In the worst case scenario, he fears it could lead to another Greek-style crisis in Europe.

He says: “It is not clear that Europe has the mechanisms to prevent such an occurrence, as it is yet to complete the banking union and is not a fiscal union.

“Peripheral bond markets have breathed a sigh of relief with the recent agreement on the Italian budget, but the drama is likely to play out again given the aims of the populist coalition.”

Ed Smith, head of asset allocation research at Rathbones, is concerned about softening sentiment among consumers and business in the region as well as slowing economic growth, not to mention Italian government borrowing costs surging.

Russ Mould, investment director at AJ Bell, is uneasy about the outlook for EU banks. “They may keep passing the ECB’s stress tests but their shares keep performing badly. The Euro Stoxx banks index dropped like a rock last year, the German giant’s shares trade at levels not seen since the early 90s, Greek banks ended the year at new all-time lows, and Italy has just bailed out its fourth bank in two years.”

Elsewhere autos giants have suffered because of trade tariffs and emissions legislations. German car maker BMW issued a profit warning in the autumn after warning on cost increases because of emissions standards and a stronger euro.

Why Should Europe Care About Brexit?

With all that in mind, it’s little surprise that Brexit is hardly at the top of the list of concerns for European investors. The European Union is reluctant to negotiate further on the terms of Brexit in the belief that the situation is more serious for the UK than Europe.

However, Richard Stone, chief executive at The Share Centre, thinks there is more to it. He says: “There is no incentive for the EU to offer favourable terms or furthers concessions to the UK, because it does not want the UK to leave. There is undoubtedly a fear within the EU that the UK leaving could be the trigger for others to look to exit too.”

Amid all of the uncertainty Philip Dicken, head of European equities at Columbia Threadneedle, says it’s important to focus on company fundamentals to find investment opportunities. Recently volatility has left a number of stocks trading more cheaply than before, despite the fact earnings growth is expected to be 5 to 10%.

He is looking for businesses which can benefit from long-term trends: “Industrial processes are being changed by new materials or legislation around emission controls, high street banks are being challenged by fintech disruptors, and there is a fast-growing DIY pensions market that did not exist just a few years ago. This all creates interesting prospects for investors.”

Mould agrees that such poor sentiment certainly means stocks look cheap, which could be an opportunity for brave investors. He says: If you believe the old adage that you can have cheap stocks and good news, just not both at the same time, then all of these issues may not necessarily put you off: pessimism provides cheap prices and these make for the best long-term returns. However, if earnings estimates disappoint, Europe may not be quite so cheap after all.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Holly Black  is a freelance journalist specialising in investments and personal finance