The Eurozone has been struggling for some time now with a combination of anaemic growth, weak bank lending and it has been staring down the barrel at the spectre of deflation. While too much inflation is bad news, too little of it can also put the brakes on economic activity - stagnant or declining prices deter consumers from spending today because they expect goods will be cheaper in the future.
For some months Mario Draghi, President of the European Central Bank (ECB), has been signalling the ECB’s potential to take more radical measures akin to those previously taken by the Bank of England, the US Federal Reserve Bank and currently being pursued by the Bank of Japan. After much anticipation and the need to overcome reported German reluctance to deviate from the narrative of austerity, this week the ECB has finally announced the launch of a €60 billion monthly bond buying blitz, commencing in March and lasting until the end of September 2016 – or until inflation nears a 2% target. The aim of this action is to increase the amount of money supply in Europe.
The experience of such actions by central banks elsewhere, has been that de-facto money printing is strongly supportive for riskier investments, notably equities. Indeed, the meteoric rise in the US stock market since 2011, which has propelled the S&P 500 Index to a record high, has in large part been due to the distortions caused by the US Federal Reserve Bank’s own bond-purchasing programme. This helped keep the cost of borrowing very low for companies, enabling them to boost profits through refinancing their debts cheaply. In turn, investors have been encouraged to invest in riskier assets as yields on bonds have remained low.
Of course markets have increasingly anticipated these measures by the ECB. Seemingly every bad piece of economic news of late for the European economy has perversely been treated as good news by the markets, since it has strengthened the case for a radical stimulus programme. In our view, the measures announced by the ECB should continue to be supportive for European equity markets. Alongside this, the slump in energy prices seen over the last year, while on the one hand adding to the downward pressure on inflation, should also benefit European companies and consumers, as Western Europe is a major net importer of oil and gas.
While there are plenty of reasons to be optimistic about the potential for European shares, a pitfall is that significant stimulus programmes like this by other central banks have led to a dramatic weakening in their currencies – a phenomenon acutely played out in Japan where the equity market and the value of the yen have moved in opposite directions since the onset of its own ‘Abenomics’ programme of aggressive monetary expansions. The euro has already fallen to a nine-year low versus the US dollar ahead of the ECB’s announcement. It is of course difficult to know for sure whether there is further weakening to come, especially if the uncertainty around May’s General Election weighs on the Pound.
Investors therefore hoping to capitalise on the potential positive effects of the Eurozone’s new ‘Quantitative Easing’ programme within their ISA or Self-invested Personal Pension but wanting to mitigate any downside risk from a weakening of the Euro versus the Pound might consider funds that seek to eliminate the risk of exchange rate movements by converting returns in euros into pounds. This is an approach known as ‘currency hedging’ (not to be confused with ‘hedge funds’). While many of our top-rated European managers do not offer such funds, two that do are Artemis European Opportunities Hedged and JPM Europe Dynamic ex UK C GBP Hedged, both of which are rated three stars and are available through our Online Investment Service.