Contrasting outlook for Europe, US

The rallying cry on international financial markets over the last few weeks has been ‘prudence’.

The truth is that the overall picture is dominated by expectations in the United States and Europe and these can change. But two significantly different scenarios emerge for America and Europe.

Financial investors will have limited choices during most of 2015. Good quality bonds, as in 2014, yield virtually nothing, low-grade bonds are too risky compared with the returns they offer, and property investments involve relatively high transaction costs.

By contrast, stocks promise a fairly reliable income from dividends and possibly some capital gains. The lack of alternatives for investors is here to stay.

The European authorities - the European Central Bank and the European Commission - keep telling markets that interest rates will stay low for at least two more years. And investors believe them, as witnessed by annual yields on 10-year German and French bonds of 0.54 per cent and 0.83 per cent, respectively.

By contrast, America’s Central Bank, the Federal Reserve, keeps signalling that rates are likely to rise during 2015. Operators there interpret these announcements as signs of economic health, rather than an impending collapse of aggregate demand. The bottom line is that the mood on each side of the Atlantic will play a critical role but with important differences.

In the US, people are sanguine about the future of the economy. The typical investor today thinks he has little to lose by keeping his money in American stocks. He is betting that stock prices will rise slowly or stay put and in this light, patience is a long-run, self-validating strategy.

Two consequences follow. Announcements regarding US monetary policy will have little impact. Low interest rates will be seen as an extra boost to growth and high interest rates as a signal of comfort. Data relating to the real economy will be far more important.

The opposite is true in the EU.

The general mood here is downhearted in contrast with North America. Data on growth, employment and fixed investment are, with few exceptions, far from encouraging. Little attention is paid to news which shows that the European economy - Germany included - is doing poorly, and not much heed is given to the less-than-reliable balance sheets of many companies. But ears are wide open when Europe’s monetary authorities announce their future moves. Investors rejoice when European Central Bank President Mario Draghi announces new injections of fresh money. They mourn when a more neutral stance is posted.

The focus is on the real news in the US and this may support the current sanguine mood or bring about a more cautious attitude. By contrast, investors in the EU take for granted that the fundamentals are weak and that most stocks are overpriced. European investors hope the central bank keeps feeding the system with monetary resources which will find their way to the stock markets and prevent them from crashing.

The future, therefore, consists in one scenario for the US and another for Europe. US investors analyse the overall health of the economy and company performances in an environment where the real challenge does not consist of beating the crisis, but rather in beating old and new competitors worldwide.

The role of the authorities in the US context is characterised less by policy announcements, and more by information about America’s economic conditions.

The European picture is different. Here, announcements are in fact statements about the kinds of distortions which may emerge in the near future. This is a future where reality will be a mix of good intentions, political expedience, internal tensions, and credibility.

This is hardly the way to put a complex and tormented economic area like the eurozone on track.

By: Enrico Colombatto