While much of the investment world is focused on what is happening across the Pacific in China, worries about the conditions across the pond continue to mount. Portfolio Manager Tom Banks weighs in on the three biggest concerns:
Brexit With the Brexit deadline quickly approaching, the U.K. and European Union (EU) remain in a stalemate. Prime Minister May’s plan was soundly voted down in the House of Commons last month and her recent trip to Brussels failed to yield progress, both hampered by debate over the Northern Ireland backstop. While all options remain on the table before March 29, in reality there are four potential outcomes. One is that, with some amendments and the growing reality of a No Deal/Hard Brexit, May secures enough support to push her deal over the line. Other possible outcomes are an extension to the deadline, a separation without a deal and a second referendum.
Italian debt The eurozone’s third largest economy is grappling with a debt burden exceeding $2 trillion—130% of its GDP. More pressing is that the coalition government has been at odds with the EU after proposing a 2019 budget deficit of 2.7% of GDP as it attempts to deliver on campaign promises including tax cuts, income for the unemployed and early-retirement pension option. Investors initially rejoiced as Italy bowed to the EU’s pressure and agreed to a 2% deficit. But that was predicated on a forecast of a 1% growth rate, which now looks optimistic. Unless growth accelerates or the government reins in spending plans, Italy’s economy will remain in a tenuous situation and a risk for the EU.
European slowdown There’s more bad news for the EU, and no way to sugarcoat the recent weakening state of its three largest countries, Germany, France and Italy. The Markit Eurozone Composite PMI peaked a year ago at 58.8 and has since been in a steady decline. January’s reading was a five-and-a-half year low, stoking concerns of recession. As the world’s second largest exporter, the trade dispute between the U.S. and China have further lowered EU business confidence. However, January’s PMI data did show some signs of stability, and low core inflation stuck around 1% might induce growth if it pushes the next European Central Bank rate hike to 2020. Political uncertainty is not going away any time soon. However, if a Brexit deal is reached in the first half of this year and global trade normalizes, we think GDP growth could return to the 1.5% to 2% range by year-end.