However, more recently there has been a shift towards anxiety over growth in developed markets and heightened fears over the developing signs of financial market distress, particularly in corporate credit and the financial sector.
Against this backdrop of uncertainty, the probability of a global recession has risen, spreading fear in equity markets and potentially creating feedback loops that could become self-fulfilling. It appears that another risk-off phase has spurred buying of government bonds and heavy selling of equities as earlier uncertainty has morphed into increased recession risk.
Cyclical forces
Despite those headwinds, it is not all gloom. In fact, there is enough evidence to suggest cyclical forces are still supportive with unemployment falling at its fastest pace since 2007, auto sales recovering, credit growth improving and consumers’ major purchase intentions are close to their highest level since early 2001.
Moreover, the latest purchasing managers’ indexes and regional and industrial country survey data all remain at solid levels.
At a sector level, volatility in energy has been extreme. Having lost significant ground last year, the sector has come back strongly this year. Indeed, Lundin Petroleum and Statoil are among the best performing stocks in the index. Oil price rallies have been led by rumours of possible production cutting deals between Russia, Saudi Arabia and other Opec members.
Precious metals
Many commentators expect a rebound towards the end of this year and into 2017. Nevertheless, the average fund in the Morningstar Europe ex UK Large-Cap Equity category remains underweight in energy. This is in keeping with findings from our analysts’ recent review of European equity fund managers who remain largely cautious on the sector’s prospects.
Somewhat unsurprisingly, given the uncertain market environment and recent financial market concerns and turmoil, precious metals are back in vogue. Most commentators remain agnostic on gold from a fundamental perspective but recognise the upside risk due to the recent financial market turbulence. Safe-haven attributes, therefore, may continue to be supportive for a while longer.
Battered banks
On the other hand, financials have been battered this year and in particular European banks, which have featured at the bottom of the performance tables. Credit Suisse, Deutsche Bank, Bank of Ireland, Société Générale and Intesa Sanpaolo, among others, are down in double digits.
It is no surprise that the average fund in the Morningstar Europe ex UK Large-Cap Equity category is underweight in the sector.
Earnings for European banks continue to be weak, with average return on equity still below cost of equity – this is despite several cost cutting and rationalisation initiatives in recent years.
Headwinds from emerging market and commodity weakness, as well as the change in the regulatory environment in relation to capital requirements, have added further pressure. While it is important to remember the crucial role of the financial sector in aiding both an economic and market recovery, it is somewhat reassuring that this is at the forefront of policymakers’ thinking.
Road to recovery
Indeed, Benoît Cœuré, executive board member at the European Central Bank, noted recently in a speech: “The euro area is still recovering from a once in a generation economic and financial crisis that has left deep scars on the economy.
“It urgently needs higher growth to bring down high unemployment, to deleverage the economy and to raise inflation back to our price stability objective. Uncertainty in the financial sector only blocks that path,” he said.
