Until very recently, the outlook for Europe was bright: the economy was picking up, inflation was abating, the European Central Bank (ECB) had enacted its first rate cut and financing conditions were easing. Economists had even raised their full-year GDP growth forecasts – something we hadn’t seen for a long time. Investors began putting their money back into European stocks, encouraged by upwards revisions to earnings forecasts and a cyclical upswing in M&A deals.
But the honeymoon was short-lived. Macron’s surprise decision to dissolve the National Assembly and call snap parliamentary elections disheartened investors. And the results show that Macron’s strategy of challenging the far right after the European elections has to some extent worked. But France is now in a very tricky situation: it’s going to be hard to form a government and bring in fiscal policies at a time when France’s public finances are in a worrying state because of the country’s ever-expanding fiscal deficit. We also can’t rule out the risk of increased social and political tensions in the autumn, which would weigh further on investor sentiment. The political climate in Germany isn’t much better: the economy there is struggling to pick back up owing to its heavy dependence on China.
In light of recent developments in France, we have every reason to believe that investors will shy away from European equities in the short term. But even though the upbeat sentiment on the region has waned, we’re far from a situation of panic or extreme pessimism. This suggests investors haven’t yet priced in the worst post-election scenarios for the economy or financial markets.
We are tactically reducing our exposure to European equities as part of our risk management approach, because the region’s stock markets have performed well since the start of the year and because we believe the political uncertainty in France could lead to higher volatility in the weeks to come. But further out, we should see new investment opportunities emerge given that the climate is still favourable to risk assets. The ECB has just begun a cycle of monetary easing, which should fuel an upturn in the economy.
Gold prices have risen firmly since the start of the year, justifying our late-March recommendation to bolster exposure to this asset. Over the past month, however, prices have tapered off, leading to a period of consolidation. This can be traced back to the Chinese central bank’s announcement that it did not purchase gold in May – news that the market saw as a bad sign. In our view, this is a temporary pause and gold buying will pick up again. Gold accounts for just 5% of Chinese reserves, and this figure expanded by only 1% in 18 months despite significant purchases. In comparison, gold accounts for close to 70% of reserves in the United States, Germany and France and around 30% in Russia. Its weighting in central bank reserves is likely to expand considerably in the coming years, as it’s one of the few assets that cannot be frozen if there’s a major disagreement with the US government.
The US services PMI came in well below economists’ expectations in June. While this indicator can be volatile, it appears to have been moving down in recent months.