Blue-chip European Equities and the Eurozone Crisis
by George Hatjoullis
The Euro Stoxx 50 is “..Europe’s leading Blue-chip index for the eurozone…” (http://bit.ly/114SiTp). A quick glance at the chart above (courtesy of IG Index) tells a unsuprising story. Whilst national indices such as the FTSE, S&P 500 and Dax are close to all time highs or making new all time highs, the Euro Stoxx 50 is some way off all time highs. Anyone with a fund tracking this index is underperforming substantially.
The Euro Stoxx 50 chart is reminiscent of the Nikkei chart before Abeconomics. The Nikkei was also languishing as other national indices powered higher, fuelled by monetary laxity. Prima facie Japan monetary policy was lax. However, as has been detailed in the previous Abeconomics blogs, monetary laxity is relative. Structurally negative inflation expectations imply a constant excess demand for fiat money. Relative to this demand, Japan monetary conditions were not lax and needed a boost. Abeconomics promised 2-in-2; to double the money supply in two years. This had the desired effect on both the Yen and the Nikkei. It does rather beg the question of what now happens to JGBs but this is another matter that has also been discussed in prior blogs.
The implication is that monetary conditions in the eurozone may be holding back Blue-chip equities. The ECB has indicated regularly that it is concerned about the transmission of monetary policy within the eurozone and the monetary aggregates do indicate little if any growth, despite the best efforts of the ECB. The reasons for the breakdown in the transmission mechanism are complex but include the fractured and undercapitalised condition of eurozone banks. For the Euro Stoxx 50 this is a dual problem as it includes 7 banks amongst its constituents.
It is hard not to conclude that the destiny of the Euro Stoxx 50 is tied up with eurozone banking reform. The ECB is unable to conduct the kind of aggressive monetary policy seen in the USA, Japan and the UK. The only real hope for monetary growth is to restore the health of the banking sector. However, this will require a resolution of the current reform of the eurozone banking system and agreement on a banking union.
Achieving an effective banking union is fraught with difficulties. A banking union is essential to the eurozone but less pressing for the non-eurozone EU membership. Indeed it is hard to see how an EU-wide banking union that meets the needs of the eurozone can be agreed. If the eurozone constructs a union that meets its own needs, this may conflict with the needs and aspirations of non-eurozone states. Then there is the thorny question of agreement, legality and treaty change. The relationship between eurozone and non-eurozone in relation to banking union is problematic.
Even if the eurozone is able to establish a union that meets the needs of the eurozone one issue may still be an obstacle; moral hazard. The key purpose of the banking union is to insulate banking problems from sovereign problems in a manner that does not introduce moral hazard. This is likely to prove much more difficult to achieve than many in Brussels are willing to admit.
Banking union is an ongoing discussion and no doubt some progress will be made. However, how long this will take and how much progress will be made is unclear. In the meantime the mechanism for money growth remains impaired. The Euro Stoxx 50 may be less interesting as an investment than as a leading indicator of progress on banking union.