Europe: Look for Value, Expect Volatility

by on December 15, 2014

Like a villain that dies at the end of a horror movie only to be resurrected in its sequel, the threat of Greek political instability is once again stalking financial markets. On Monday, Greek Prime Minister Antonis Samaras surprised everyone by moving up the date for a parliamentary vote on a new president, a largely ceremonial position. It is unclear whether Samaras’s existing coalition with 155 seats would be able to obtain a supermajority—180 out of 300 lawmakers—to pass that vote. Should they fail, this would precipitate a snap election. Based on recent polls, the likely winner of that election would be the far-left party, Syriza, who would probably be forced to govern as part of an unstable coalition. The news unnerved investors, sending Greek stocks and bonds tumbling and in turn raising the question: Are we in for another round of European led volatility? Here is my read.

European politics will matter in 2015. After a year with relatively less drama, European politics are likely to return to center stage next year. In addition to the fragility of the Greek coalition, several European countries are facing similar challenges. As Podemos in Spain and the National Front in France rise alongside a resurgent Northern League in Italy, formerly nonmainstream parties are gaining wider support with their populist platform and in some cases, extreme skepticism concerning the European Union and the common currency. Greece may represent the near-term threat, but other countries could add to the angst in 2015.Greece

The European Central Bank (ECB) can mitigate risk, but only if they act more boldly. ECB President Mario Draghi has been a master of rhetorical flourishes, convincing investors of the central bank’s commitment in doing more to ease conditions and support the bloc’s economy. Unfortunately, the reality has been more prosaic. Despite expanding their asset purchase program earlier this year, the ECB’s balance sheet is still 10% smaller than it was 12 months ago. If the central bank does not take further stimulus measures, investors are likely to be disappointed, which will hurt European asset valuations.

Look for value, expect volatility. With all that said, there are parts of the European equity market that appear attractive, particularly cyclical companies in northern Europe. Many of these firms sell their products and services globally, but their stock prices have been discounted due to the fact that they’re domiciled in Europe. A word of caution: While European cyclical stocks may offer some value, a high level of volatility is to be expected, particularly if the ECB is slow to act.

With the U.S. midterm elections over and the presidential election still two years away, 2015 may be a year of relative calm, though not of productivity, for American politics. Not so in Europe. Reform efforts are facing growing opposition from populist parties and fatigued voters. Although the ECB can and probably will mitigate the volatility with more easing efforts, politics will be a source of headline risk for European assets in 2015 and probably beyond.

Source: Bloomberg

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.

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