'The rest' catching up Germany

European growth optimism

The low volatility grind higher in equity markets continues with stunning consistency. Everybody knows there has to be a big shake-out sometime but the momentum is still firmly higher. Surprisingly good Eurozone economic data and a breakout in crude oil prices kept the optimism alive despite rising election tensions. The Euro Stoxx 600 index hit its highest since early December 2005.

Poorly-received fourth quarter results from HSBC, a large component of the FTSE 100 meant the UK benchmark index was acting a little soft in a context of broader optimism. If the breakout in oil prices is sustained, it would be a positive for the UK stock market. The FTSE 350 oil and gas sector fell to its lowest since November this week and has been a drag on the broader rise in equities this year.

Wall Street opened at record highs on Tuesday after Walmart reported its best US sales in four years as higher oil prices led a jump in the energy sector.

‘The rest’ catching up Germany

The Eurozone composite PMI rose to the highest in almost six years in February. The Composite PMI for France rose above Germany’s for the first time since 2012. Not only is Europe seeing its strongest growth in years, it appears to be more evenly spread. If Europe were to break out of its ‘two-tier’ economic model of Germany versus ‘the rest’, the economic recovery would be on a much more sustainable footing.

Ironically, just as economic growth become more evenly distributed German stocks are outperforming. Investors looking to invest in the safer ‘core’ of Europe feel compelled to invest in Germany to avoid the political risk in France.

In a sign of relative weakness, the euro fell against most major currencies despite the upbeat data. Political risk is clearly trumping economic strength in the currency market. Markets expect the European Central Bank to avoid tapering its asset purchase program early to backstop any election upsets. We are more skeptical. The ECB calling the rise in Eurozone inflation “transitory” is a clever delay tactic but can’t last. Eventually the ECB will have to react to higher inflation and we think that could come before the December deadline for the end of the QE program.

Gulliver’s HSBC travels lower

Shares of HSBC saw its biggest daily drop in 18 months after missing revenue forecasts and warning it could fall again this year. A $1bn increase in its stock buyback program did little to contain the disappointment. Although HSBC chief executive Stuart Gulliver may have had better days at the office, the 40+% gain in the share price since Brexit should help him sleep just fine.

These results were a dash of reality for investors in the banking sector who perhaps got a little ahead of themselves in hopes of financial deregulation, higher global growth and rising interest rates. The quarter included some heavy write-downs including for its disgraced European private bank. With lower write-downs and more time to benefit from higher global rates, we would expect next quarter to be a bit rosier.