A United Europe | Top Down

23 July 2020

We have had some firsts as a result of the COVID -19 pandemic and this week delivered another. The leaders of the EU countries have agreed to a commonly funded fiscal package for the Union. The Commission will disburse €750bn, of which grants will make-up €390bn and the rest will be loans raised by the EU and passed onto applicant countries. There are still some hurdles to overcome, each national parliament will have to pass it and it will be debated in the European Parliament. So, expect some noise but that is all it is likely to be.

Do not underestimate the political message

The EU has long been criticised by international commentators as being slow and ineffective in dealing with the problems it faces and lacking cohesion. Let us not forget at the start of the Great Financial Crisis, Germany passed its ‘Balanced Budget’ amendment to its constitution just when its partners needed some help. That is what is so different this time. The COVID-19 crisis broke in March and just 3 months later we have a commonly agreed fiscal package on its way for approval in the national parliaments. Moreover, the summit was not concluded until a deal had been thrashed out, where a deferral to the following month would have previously been more typical. This indicates a new sense of urgency within the Union. It is also noteworthy that it is Germany and France that have been the main promoters of this plan and would have preferred a larger element of grants within the package. We have come a long way from 2008.

What does it mean?

The main positive from these developments is an increase in confidence in the Union from overseas investors and in particular in the US. Anytime there has been stress there has always been a concern as to whether the Euro could be maintained. Peripheral spreads would widen and euro area assets would underperform. This time the major players have ‘put their money where their mouth is’ and directed the aid towards the peripheral economies. This should put the Euro on a strengthening trend and improve the valuation of all types of euro area assets. It should, in time, lead to greater inflows into euro area markets. With this agreement in place, and once we get the inevitable noise out of the way, the political outlook for the euro area should look much more stable than the US which will be heading towards a very uncertain election period.

It is not all green grass

The mix is not strong as initially proposed: grants make up less of the total, €390bn instead of €500bn, but the other impact is that more of the package will be directed to the periphery since they are the only ones that would benefit from the lower cost of debt. There will be a time lag before we see any result from this plan. The earliest that we are likely to see any actual spending from this plan is the second half of 2021. Accordingly, it does not really affect any near term economic or earnings forecasts. Another item to bear in mind is that governance of the programme is not solely with the Commission. The European Council (heads of government) will also have a ‘policing function’. This does leave the potential for frictions between individual countries but that is only going to happen when we are some time into disbursements. So that is probably a 2022 concern.

What do you do as an investor?  

For us in Goodbody we got great comfort from these developments. For some time, we have had a large exposure to euro area equities and 90% of our fixed income exposure is in the euro area. At the end of 2019 we had another year where the euro area equities underperformed and the peripherals were holding back the returns from the fixed income markets. We were wondering if it was time to alter this as nothing on the horizon seemed to indicate any change. That is different now as we see a big improvement in cohesion and a recommitment to the goals of the Union. The periphery will get further support which will help their bond markets. A fiscal plan will help the growth potential for the region which will help the equity markets. A firmer currency will augment returns from the region. This leaves us comfortable with the large allocation we have here.

One item we are looking at

What we are considering in Goodbody is what will be the nature of the spending. It appears to us that ‘green’ items are going to register higher. Part of the implementation of the plan is likely to include tackling carbon emissions through moving towards clean energy, electrification and promoting energy efficiency. We have started increasing our exposure to these areas and you are likely to hear more from us on this topic.


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