Confronting Europe's elephant in the room
It has been a strong showing for European equities in recent weeks, with the European Central Bank (ECB)'s policy action – and the rate cut in the US – all helping to lift shares higher.
However, if one looks under the hood, European economic output is the big elephant in the room for the region now.
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What should be chief among investors' concerns? We have a very weak manufacturing industry in Europe, with German manufacturing now in one of the deeper recessions seen over the last 25 years.
On top of that is, of course, Brexit. And while the European Commission remains positive on the outlook for growth and jobs broadly, earlier this month it conceded the external environment has become "much less supportive".
The ECB has reacted with additional stimulus, while leaving rates on hold in its most recent meeting.
For those looking for positives, there is now a case to say that if the euro devalues from here it will make the region competitive, and when combined with a fiscal response it will lift growth.
There is also a suggestion that, after a drop of the magnitude seen in the Purchasing Managers' Index, it may now bottom out.
However, a lot of concerns remain. There is a real risk that monetary policy does not work anymore in Europe, and indeed our traffic light system is flagging negative earnings revisions and lofty valuations as two reasons for investors to be cautious now.
At a sector level, the outlook is more nuanced. Some regions - such as Hungary - look attractive now, and we are long banks in that country, for example.
The different economies in Europe move at different speeds, and the deep economic recovery in Hungary is now coming to fruition, with growth tipped to be 3.5% in 2019.
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The biggest beneficiary of that is the country's banking sector, and it is in much better shape than other regions, in particular Spain.
The Spanish economy, and the Spanish banks in particular, are still burdened with mortgage loan issues from the last crisis, and things are not so sunny in Spain anymore.
Michael Browne is manager of the Legg Mason Martin Currie European Absolute Alpha fund
Bull Points
• Stimulus from the ECB could boost growth
• Specific regions enjoying a resurgence
Bear Points
• Monetary policy may not boost growth or shares for much longer
• Negative earnings revisions and lofty valuations pose dangers to shares
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