Recent client visits uncovered that investors are uniformly bearish on Europe. What could go right?
We offer two potential candidates for upside surprises in Europe:
- European banks have been hesitant to lend ever since the AQR/stress-test exercise was announced at the end of 2012. Our view is that most banks will likely pass the test (results are expected at the end of this month), largely because of the severe deleveraging undertaken throughout late 2013. This would relieve a serious constraint on the supply of credit and risk assets should benefit.
- At present, there is a small projected fiscal drag for the euro-zone next year, but the most likely outcome is that this is reversed. Our geopolitical strategists remain convinced that Europe is slowly developing a consensus around the quid pro quo of structural reforms in exchange for the end of austerity. The current pace of fiscal consolidation is simply politically unsustainable, as recent Pew polls clearly illustrate.
Bottom Line: Extreme bearishness on Europe invites a contrarian stance and suggests that any slight policy surprise could cause a positive reaction in euro area equities. Stay tuned.