September 2024

“The Euro is much, much stronger, the euro area is much, much stronger than people acknowledge today.”  Mario Draghi, July 2012

“Growth has been slowing down for a long time in Europe, but we’ve ignored it…we cannot ignore anymore.”  Mario Draghi, Sept 2024

After a relatively quiet summer, September was an action-packed month for both news and markets, more of which later, but we start on the subject of Europe, and a report on economic competitiveness by Mario Draghi which was released early in the month.  Since the end of the Global Financial Crisis (GFC) about fifteen years ago, Europe, or specifically the Euro area has had to deal with several acute debt crises, and each time the ECB has eventually provided the salve (e.g. LTRO, QE) that has solved the immediate crisis without requiring politicians to deal with the difficult strategic issues that lie at the heart of the currency union.  Those issues remain latent but have manifest themselves in a crisis of low productivity and economic growth, summarized in Mr Draghi’s report.  Unfortunately, his recommendations – increased government investment financed by borrowing – is unlikely to lead to a sustained period of growth, much less close the gap with the US economy given many other structural issues.   Perhaps nothing better illustrates the dilemma like the reaction to the recent announcement that UniCredit had acquired a large stake in Commerzbank and was interested in pursuing a takeover.  Somewhat predictably, the Germans are opposed to the deal while the Italian government supports it, suddenly forgetting the crucial question of which would be responsible for a clean-up in the event of failure (memories are shorter than the lifespan of most governments) and highlighting that for all the talk of single markets there is still no banking union of single capital market.  More on the deal later on, but fundamentally it appears that we have finally got to an economic challenge that can’t be fixed with easy money but will require meaningful statesmanship and difficult political decisions.  What’s at stake is nothing less than the continuing sustainability of the European project.

Elsewhere the big news was the concerted rate cuts executed by central banks – the ECB and SNB cut 25bp while the Fed cut 50bp – amid continuing softening economic data across Europe and North America.  There was particular focus on the size of the Fed’s cut, with a consensus shifting to 50bp only recently.  And while a number of future cuts remain priced into the yield curve, the consensus of opinion shows greater divergence in expectation for the US than in Europe, where there has been more progress on lowering inflation.  Markets reacted positively to these actions and to the news that the Chinese government undertook significant stimulative measures that fuelled a late-month equity rally, but our view remains that we will need to see a steady flow of supportive (weakening) data to justify expectations.

Banking news was dominated by the aforementioned banking deal in part because the stake building by UCG was conducted sub-rosa and in part because of its audacity.  Nobody expected it because it’s not obvious to anyone other than M&A bankers and journalists that it makes sense.  While UCG has a German presence (the old HypoVereinsbank) any synergies would have to be cost driven, and the likelihood of job cuts in Germany – driven by a foreign-owned bank – would seem slim.  Also, despite neutral comment from the ECB, does the central bank and regulator really want to create a large multi-centred bank without a clear line back to a single lender of last resort?  Surely the Italian government’s enthusiasm would melt faster than cheese on a lasagna if it found itself having to deal with a “made-in-Germany” bank panic.  Lastly, UCG shareholders should remember that the previous CEO spent most of his tenure untangling foreign ventures that were a hinderance to the post-GFC recovery of the bank.  Regarding the general question of cross-border bank M&A, our view has consistently been that in the absence of a single pan-European market banks should focus on domestic deals where the benefits are tangible.

For the month the funds A shares rose 1.18% mostly driven by credit’s 145bp gross contribution with equities down 5bp, with very little shifting of our portfolio.  Looking forward, the onset of an easing rate cycle places renewed emphasis on upcoming economic data, as well as Q3 earnings releases and strategy updates from banks, some of which could bring catalysts for our holdings.  And, as we enter Q4 we are also paying particular attention to market technicals ahead of the US election in November.