Pundits have repeatedly proclaimed the end of Europe’s monetary union in recent years. And where are we today? The euro still exists, there were no disorderly bank or sovereign collapses, and no country has left the union. …
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Mikio Kumada, Global Strategist at LGT Capital Management
In fact, despite the tremendous financial and social cost of unity, euro membership has actually increased. As things stand today, the region’s problems seem to have long been discounted, allowing the euro area’s equity markets to join the ranks of the world’s top performers.
Eurozone equities: no longer laggards
If we rank the world’s stock markets by their performance since the start of the current bull market in March 2009, the euro area still lags the US. Including dividends, the MSCI USA has returned around 140% since then, compared to a comparatively modest 76% delivered by the MSCI EMU. However, that’s not too far behind compared to the Emerging Markets (86%) and Asia-Pacific (94%), and broadly in line with Japan (74%). Furthermore, the euro area’s performance relative to the US has started to stabilize over the past year – although performance has been quite volatile, ultimately, the euro area index has returned about 22% since end-July 2012 – just 2% less than US benchmark. It’s clear that eurozone equities have finally started to catch up.
Nearly all European stock markets now participate in the bull market
In addition, a closer look at Europe’s two dozen markets reveals that the region’s stock market rebound is now broad-based. If we look back five years, it was the non-euro-members that rallied first (i.e. United Kingdom, Sweden, Denmark, and, with a time lag, Switzerland). These markets have been keeping up with the US from the early days, and are still the only ones outside of the US that are trading significantly above the levels before the collapse of Lehman Brothers in September 2008 (chart 1, page 2). But if we look back over the past year, we can see that practically all euro-markets – including Greece, Portugal, Spain and Italy – have finally started to fully participate on the upside and even outperform in many cases. Overall, the euro area indices have also been outperforming the emerging markets and Asia over the past year (table, page 3).
Reasons for continued euro area strength in equities
The euro market stabilization is significant and should not be ignored. Firstly, a trend can always feed on itself to a certain extend.
This is true for bear markets, as well as bull markets – and at present we have pronounced bull markets, at least in the West and Japan. The euro region should continue to benefit from this, and it’s worth noting that some investment banks have started to turn more positive on the region. Secondly, there have been some indications of a possible economic stabilization in the euro area more recently. The region’s composite purchasing managers’ index climbed back above the growth threshold of 50 points in July for the first time since early 2012, for example (chart 2, page 2). Even in Europe’s south, which is still mired in deep recession, there is light at the end of the tunnel. Thirdly, as a whole, the eurozone is now running a significant current account surplus (economic overview, page 4), which can help end the mild recession that has persisted since late 2011, just as the European Central Bank predicts.
The European Central Bank’s “reinsurance” option is still valid
The main reason for the slow but steadily improvement of the euro area’s market prospects, however, still rests with the powerful “reinsurance option” provided by the ECB against the eventuality of a resurgence of the so-called euro crisis. Thus, monetary policy in the euro area will not only remain more generous than in the US for quite some time – it will also be supported by an explicit, albeit conditional, option of additional monetary stimulus – be it due a return of the periphery’s debt crisis, or sluggish economic growth. Moreover, the effect of ultra-expansionary monetary policies, which was more controversial initially, is now more widely recognized, at least in terms of their impact on equity markets. After all, wherever central banks decided to open the spigots of money as widely as possible, equity markets soared, and outperformed. The central banks in the US and the UK were the first to show no inhibition in launching such policies, followed by Switzerland in September 2011, and Japan in late 2012.
Eurozone equities have been “stealthily” catching up over the past year
All stock indices began rising in March 2009, led by the US, and followed closely by “Europe excluding the eurozone” (representing the UK, Switzerland and the Scandinavian countries). The US, British and Swiss central banks were the first to adopt large-scale purchases of bonds or foreign currencies (in the case of Switzerland), which boosted their stock markets. It took Japan until late summer 2012 to join the rally, just when it became politically clear that the Bank of Japan would also launch an aggressive asset-purchase program. The chart below illustrates how Japan (dark red line) and the euro area (dark green) were laggards until mid-2012. But then, the ECB announced the OMT program, which provides for potentially unlimited purchases of troubled euro-member sovereign bonds. Although the OMT has not been activated to date, it has not failed to impact markets, and the upward momentum of euro area stocks has improved since. That uptrend is less steep than the US (and non-euro European) path and less volatile than the Japanese one (on the upside, as well as the downside), but it appears quite stable. In other words, eurozone equities have been “stealthily” catching up over the past year. Last but not least, is also clear that almost all European markets have participated in this
uptrend, including all of the larger crisis countries (see table and chart on page 3).
The euro area’s economy may be about to return to growth
The composite Purchasing Managers’ Index for the eurozone represents both manufacturing as well as the services industries throughout the currency bloc. This leading indicator returned into positive territory in July, with a reading above 50. The chart also shows that the slump in industrial production in the region – which has been constantly declining on an annual basis since October 2011 – may be finally waning. 
LGT Asset Allocation Strategy
Tactical allocation following last regular review on 23 July 2013
Significant overweight in equities, due to pronounced preference for the US and Japan. Fixed income remains underweight (corporate debt below neutral), with duration recent raised slightly above neutral. Overweight in US dollar is maintained.
The LGT Capital Management strategy team reviews and sets investment policy every quarter. It also makes intermediate and ad-hoc decisions as necessary.
The tactical positioning is shown as a minor, moderate, or major deviation from the strategic (or “neutral”) quota allocated to each asset class in mixed portfolios.
Some deviations may at times appear to contradict fundamental economic views due to various portfolio considerations (e.g. risk exposure limitations, technical market moves).
The table on the right shows a simplified overview of the tactical positioning that summarizes the positions of the various asset allocation strategies of LGT Capital Management. Some portfolios may deviate somewhat from this schematic positioning.
This overview shows the general bias in our tactical positioning and is intended for general informative reference only. 
Source: ETFWorld – LGT Capital Management
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