Last week, after five days of intense negotiations, EU leaders finally reached a deal on a €750bn recovery package to reconstruct the region’s pandemic-stricken economies. An agreement on the next seven-year budget, which will be worth over €1 trillion, was also reached.
The EU recovery plan will allow Brussels to borrow up to €750bn in the financial markets and hand it out as budgetary support to EU member states. This will be achieved by issuing a range of bonds, repayable by the end of 2058.
The plan will include €390bn of grants (which will be distributed from 2021 to 2023) and €360bn of loans, with almost a third of the funds being earmarked for targeting climate change.
To obtain a grant, a member state will have to prepare a national recovery plan detailing how it will reform its economy, which will be distributed from 2021 to 2023.
Several compromises and ad-hoc solutions were required to help get the deal over the line and the rules determining how the money is shared out between countries, and the oversight mechanisms to ensure the money is used on reforms, were among the most contentious aspects.
In the end, leaders agreed to clearly link countries’ allocations of recovery money to the economic harm they had experienced by the pandemic, rather than relying on pre-crisis data on growth and unemployment.
The governance of the recovery plan was also made more complex. While no member state has a veto power to stop the distribution of aid to another member state, the newly adopted ‘super emergency brake’ gives any member state the power to temporarily (three months) block Brussels’ financial transfers to another country if they believe reform commitments are not being honoured.
There is some scepticism as to whether the plan will work: consensus forecasts estimate that eurozone growth contracted 15% year-on-year during the second quarter of 2020, but the recovery fund is only expected to deliver a 6-7% boost – a boost that will not begin until the start of next year when the first grant is paid. That said, the ability of the EU to reach this agreement in the first place has been seen as a huge positive.
Anna Stupnytska, global macro economist, Fidelity International, commented: “Despite the compromises involved, the agreement on the recovery fund sends a strong political signal which could mark a new chapter in the Union's history. EU bond issuance will create a precedent which could become a permanent feature of the institutional framework going forward.
“With fiscal policy finally stepping up to facilitate the post-COVID recovery, the European Central bank is no longer 'the only game in town'. This powerful combination of monetary and fiscal policy, as well as the strong political will to not just ensure the union's survival but indeed its success on a number of dimensions, now has the potential - perhaps higher than ever - to lead to more superior economic outcomes in the years ahead.”
Paul O’Connor, portfolio manager, Janus Henderson, added: “The direct macroeconomic impact of the recovery fund will be fairly modest, compared to the economic damage wrought by COVID-19 on the eurozone economies. Still, the symbolism here is very important. The recovery plan will be financed by joint debt issuance, representing the eurozone’s first real attempt at mutualising debt and its biggest step yet towards fiscal integration.”
Equities in Europe have outperformed U.S. and global shares since mid-May, when the stimulus proposal was first announced. The MSCI Europe ex UK index has returned 14.6%* compared with 8.8%* for the MSCI All Companies World Index, 6.2%* for the S&P 500 and 3%* for the FTSE 100.
Paul O’Connor continued: “We see scope for further outperformance of eurozone assets from here. Although sentiment has already improved regarding the region, investor positioning is by no means excessive. Global investors have begun to reinvest in European stocks in recent weeks, but the region has seen €30bn of net outflows this year and three years of trend outflows from European equity funds.
“Furthermore, while many features of the eurozone economic and political backdrop have paled in comparison to the US in recent years, the tide seems to be turning here. Europe has handled the coronavirus much more effectively than America, and for the next few months at least, can reasonably be seen as offering global investors a refuge from the political storms that lie ahead in the US.”
Chris Iggo, CIO Core Investments, AXA Investment Managers, concluded: “The strongly developing consensus appears to be pro-Europe relative to the US. A stronger euro and a negative view on US equities is part of that. The political and health situation in the US is beginning to undermine investor confidence, while the European deal has boosted the outlook on this side of the Atlantic.
“However, long periods of Euro and European equity outperformance versus the US have been rare. The last time was between 2001-2008. The key is whether the post-recovery deal period generates the same growth and confidence as those early years of the single currency. For now, Europe is cheaper, and the short-term news flow is better.”
The manager of this fund has over 30 years of investment management experience. He mixes mega and large-cap holdings with some mid-cap stocks and looks for opportunities by anticipating change and inflection points in companies and industries – either for the better or for the worse.
This fund offers a focused, high conviction portfolio of quality growth European equities, with no constraints on regional or country allocations. Whilst the portfolio is bottom-up the manager does like certain themes: the future of technology; resource scarcity and demographic change.
Manager George Cooke focuses on small and medium-sized businesses in Europe, which offers him a huge choice of investments that are under-researched by the wider market. Each holding will also offer an attractive dividend yield, or the potential for dividend growth.
This fund invests predominantly in large-cap European equities. The manager has developed a distinctive process that focuses on industry structure and a company’s competitive position. Firms that can defend their margins and industries with barriers to entry are preferred.
*Source: FE Analytics, total returns in sterling, 18 May 2020 to 23 July 2020
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and managers quoted and do not constitute financial advice.