Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s episode, we talk about the European economy with Morten Springborg, global thematic specialist at C Worldwide Asset Management in Copenhagen. We looked at threats to the larger economy, vulnerable sectors, and inflation. And we started by asking what it will take for Europe to recapture investor confidence.

Morten Springborg (MS): Yeah, that’s a good question. I guess what is needed in order for us to have investor confidence returning to European markets in the short term, it would have to be a ceasefire. The immediate effects of the invasion in Ukraine is, of course, that as we speak we have millions of Ukrainian refugees in Europe. And that is not a problem. We are welcoming them, and we can handle bigger numbers. But higher food and energy prices could actually initiate a second immigration wave hitting Europe. And that is going to be politically destabilizing. So, we need to see a ceasefire and have a sense that stability is returning before we can talk about investors coming back.

How this could affect European politics.

MS: Europe is moving closer together, politically. And rearmament will now be happening on an unprecedented scale. What is interesting is that the E.U. bureaucracy is not letting a crisis go to waste. The ever-closer integration in Europe only happens through crisis. We had one example during Covid where for the first time it was accepted that the E.U. Commission could issue common denominated debt that all countries would be liable for. Now we are going to talk more common defence policies in Europe, and we are also going to be issuing common debt to subsidize energy bills. That was announced last week. So, I think one of the effects of this longer term is that Europe is going to grow up, and countries that previously were against deeper political integration will accept that it is unavoidable. This is going to happen.

The current economic picture.

MS: It is probably quite risky to invest in consumer discretionary, consumer staples and financials today in Europe. Of all the major regions in the world, I would expect that the likelihood of a recession is largest in Europe. But whether that’s going to happen is, I think, very, very difficult if not impossible to project right now because at the end of the day it depends on how long this war drags out. If we stay at these extremely high energy prices for, let’s say, a quarter of a year, I would expect that Europe in aggregate probably would go into a recession.

Why financial stocks were hard hit.

MS: Yeah. If you go back into the latter parts of 2021, there was this idea that we would have reflation, higher interest rates, the end of QE, and the ECB would start an interest rate hike cycle. And that typically is favourable for financials, especially in Europe because financials have been burdened with negative interest rates now for many years. Of course, events in Ukraine have at least momentarily stopped that story from happening. There is communication from ECB that we will have a tapering of QE, as well as, hopefully, interest rate hikes. But I think that is probably going to be unrealistic, and markets are reflecting that by dumping financials. The second thing is that a number of the major European banks have ties to Russia risk. So that’s another reason why people have been selling financials.

And finally, the impact of energy inflation.

MS: Last week the Commission put out a report where they said that we could basically cut our dependency on Russian gas by, I think, two thirds this year. And I find that that is highly, highly unrealistic. According to our sources, there is basically no availability of cargoes. So, I think that is very, very wishful thinking. It’s going to take a long time, I think it’s probably going to take all of the 2020s for Europe to get independent on energy. Which also means that probably energy prices will continue to be very high and suck growth out of Europe in this time period. We will have to make ourselves much more energy independent. It’s going to cost a lot of money. That means that we will have to have some sort of a common fiscal backing. So, from a relative point of view, it is good for equities. Longer term, it is of course very uncertain.

Well, those are today’s Soundbites brought you by Investment Executive and powered by Canada Life. Our thanks again to Morton Springborg of C Worldwide Asset Management.

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