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Europe: Chinese whispers drown out Brexit noise

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Summary

Putting the UK-EU split into perspective with a look at the wider world.

2 min read

Brexit may be filling the headlines in Britain but in Europe investors are far more worried about China than the UK.

Eurozone manufacturing revealed its lowest activity levels in nearly six years this week, indicating an industrial recession – according to the IHS Markit purchasing managers’ index. This is just the latest data point showing that activity in Europe is slowing down.

At Coutts, we predicted Europe’s woes and reduced our investment in the region’s equities throughout 2018. This has proved to be the right thing to do. While European stocks have bounced back this year, following the global trend after December’s sell-off, it’s still one of the worst performing of the major equity markets over the last 12 months.

The European Union is made up of 28 diverse economies, which means its economic challenges are similarly varied. But one factor is having a big impact on most European countries – exports to China.

China has been struggling as it attempts to move away from an export-led economy to become a more self-reliant domestic economy. This means it’s been cutting back its external spending and, as it’s a major importer of European goods, that’s been hitting Europe hard. 

Coutts investment strategist Lilian Chovin says, “We study these cause and effect links between world economies constantly. It is one of the chief ways we endeavour to position our clients’ portfolios and funds so they perform as well as possible whatever the market conditions.

“The current uncertainty surrounding the UK is not really an investment issue for Europe – I seriously doubt anybody looking to invest there is worried about it. They are instead looking closely at its relationship with China.”

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“The current uncertainty surrounding the UK is not really an investment issue for Europe – I seriously doubt anybody looking to invest there is worried about it. They are instead looking closely at its relationship with China.”
Lilian Chovin, Coutts investment strategist

But then there’s the chance of a no-deal…

That’s not to say that the UK’s neighbours are completely nonchalant about Brexit. While not necessarily the key driver behind Europe’s stock market performance, a no-deal would be a big deal for the continent – economically and politically.

Lilian says, “Europe is a close trading partner of the UK and many European companies make their products, or parts of their products, in Britain before exporting them elsewhere. That is currently cheap and straightforward to do but could become much more troublesome if we had a no-deal Brexit.

“Depending on the terms of the UK’s exit, these companies could end up having to pay tariffs to move their own products across borders or reshuffle their operations to accommodate the new UK-EU relationship. This creates a huge, extra challenge at a time when they need it least – because of their struggles with reduced demand from China.”

 

Cracked China?

One of the most important examples of Europe’s strong links with China comes from its largest economy – Germany, which only narrowly escaped a recession last year. In 2018, the 30 companies in Germany’s DAX stock index made 15% of their revenue, or €200 billion, from China, according to the Federation of German Industries.

But there’s hope.

While China’s economic growth has slowed down – at 6.6% last year, its slowest since 1990 – there are now signs of stabilisation.

The Chinese government has put a number of measures in place to give its economy some much-needed support. This includes cuts to income taxes and VAT, some reductions in import duties and lower short-term interest rates.

Perhaps the biggest development to bolster China has been gradual progress in its trade talks with the US. A US-China bilateral deal is looking increasingly likely and we could even see a summit between presidents Trump and Xi by June.

In fact, while the potential for a protracted and fractious trade war was considered a key market risk last year, falling levels of bellicosity on both sides are a major reason behind this year’s share price recovery.

Lilian says this all has potential to change Coutts view on Europe.

“We are keeping a very close eye on developments in China. If it improves significantly, our outlook on Europe could improve too. And although it remains to be seen whether the Chinese government’s strategy will work, it is certainly not beyond the realms of possibility.

“We remain agile as investors and ready to move quickly as the economic landscape changes.”

When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

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