Do numbers speak louder than words? Apparently not. In Europe many global investors are still tuning in to the habitual market narrative.
This is a story so uninspiring that even some astute investors have dialled down their intel alerts and rely on a loop of accepted opinion about the dismal future prospects of the European marketplace.
It is tempting to succumb to this dialogue, since rarely has anything emerged to disrupt it. The challenges and risks associated with Europe and its return to long-term stable growth are so well known that they may not be worth re-examining.
We, however, have taken a slightly different approach, the first principle of which is to pay most attention to those who have real “skin in the game”. What they say matters. The second principle is never to switch off our intelligence radar but to continue to look for unusual perspectives and insights that might keep our investors ahead of the curve.
The European scenario at the moment is this: there is subtle and nascent economic growth across the region. Two out of Europe’s biggest three economies are growing significantly. Yet investors are unwilling to accept the idea that a bloc still vulnerable to deflation risk can, and will, exhibit strong and enduring expansion.
Understanding how to respond to this is critical to our task as an investor of capital and we constantly scour the research community for data and intelligence that helps frame this debate. Just such material landed on our desks in the form of an article from the Bank for International Settlements, published in the most recent edition of the Journal of Economic Literature.
Based on an academic paper, BIS looked at the role of deflation risk in 38 countries over 140 years. It found that deflation comes in different forms and that over time each form has different effects. Further, it found no evidence that falling prices of goods and services are bad for economic growth per se.
In fact, negative economic growth effects from prices only appeared when asset prices were allowed to fall as well, although the intensity of the negative effect was very sensitive to the level of debt underlying the economic asset base.
Put simply, the BIS research suggests that stabilising asset prices is the key to mitigating deflation risks, allowing economies to benefit from the effect lower-priced goods and services can have on real incomes. A secondary message is that asset price reflation is a necessary condition for full recovery, particularly in indebted economies.
The analysis suggests that property prices are critical as a determinant of the effects of price falls in the real economy. The property cycle is long and property’s role as collateral impacts consumer and financial sectors, causing deeper balance sheet effects.
The BIS research infers to us that central banks now view driving up property values as a critical part of a successful deflation risk management strategy. That is a powerful and positive message, however subliminal, to real estate investors.
Given the downbeat macro-economic view on Europe, regional asset prices have decreased in US dollar terms, and real estate remains inexpensive relative to negative yielding bond markets, but the sceptical sentiment persists.
In our view, Europe has been able to rebuild capital markets institutions that function more effectively, and ones that have begun to deal better with financial volatility.
In 2015, Europe’s policymakers are more market-savvy. They can deal with a range of risks, from Greece to abrupt falls in commodity prices. Politics inevitably mean that EU institutions move slowly but we see no reason they should not manage to cope with the challenges presented.
The real economy appears to reflect this. Sentiment indicators continue to strengthen. It seems like Europe is dragging itself back to its feet. But the numbers are telling a story many crisis-weary investors seem reluctant to hear. Don’t tell everyone, but Europe may just creep up and surprise us.
