The Non-U.S. Developed markets—defined primarily by Western Europe, the United Kingdom, and Japan—have struggled over the last several years from slowing economic growth, less effective monetary policy, political uncertainty, little to no fiscal stimulus, and concerns over the stability of the European Union. At the beginning of 2020, that lackluster story remained the same. Coupled with Brexit[1] and growing trade tensions with the U.S., the Non-U.S. Developed markets were unattractive relative to other markets.
Fast forward six months and many of those issues have changed. Similar to all other regions around the globe, the global pandemic halted economic activity creating a sharp drop in growth in the UK, Japan, and the Eurozone in the second quarter. To combat the damage caused by the shutdown in activity, all three regions expanded monetary policy, established large fiscal packages, and enacted public health measures to limit the spread of the virus. While Brexit and trade tensions with the U.S. persist, the strong public health measures and the unprecedented, coordinated fiscal policy response lead us to have a more favorable outlook on the region.
The European Union is the largest part of the Non-U.S. Developed markets and consists of 27 member states located in Europe. Over the past decade, the European Union has been challenged by slowing growth from the aftereffects of the Great Financial Crisis, skeptics of the European Union, Brexit, immigration, terrorist attacks, and the inability of the member states to create a cohesive fiscal strategy to support the Union. While the health crisis weighed on growth and slowed economic activity to almost a standstill in the second quarter, the policy response and public health measures have been swift and decisive. The divisiveness of the member states has turned into a coordinated effort to preserve the lives and livelihoods of its citizens. In addition, both the UK and Japan have enacted large fiscal and monetary policy measures as well as public health mandates to stem the aftereffects of the disruption in economic activity.
One key to lessening the economic disruption is protecting the labor market. Stemming unemployment protects household income and builds confidence. Historically, government intervention has been more prominent in the private sector within Non-U.S. Developed markets than in the U.S.; and this crisis has been no different. In the U.S., the CARES ACT is providing expanded unemployment benefits until July 31 and Paycheck Protection Loans as an incentive for companies to keep employees until August 8. While helpful, these strategies were indirect and provided more flexibility for companies to lay off employees even for a short period of time. Further, the expanded unemployment benefits provided some unemployed individuals with a disincentive to seek employment. The limited time horizon for the support—just four to five months—has led to higher unemployment, with the current rate at 11.1%[2], higher than it ever was during the Great Financial Crisis.
In contrast to the U.S. response, Europe, the UK, and Japan’s fiscal policy had a more explicit role with the private sector, interacting directly with companies to protect employees. For example, the UK is covering 80% of the wage bill of workers in affected areas, while Germany is covering the pay shortfall that its companies are facing. These more direct measures have limited the increases in unemployment (see chart to right), with unemployment in Europe at 7.4%, 3.9% in the UK, and 2.9% in Japan, through June. Additionally, the time horizon for direct fiscal support to the private sector to protect employment is longer than in the U.S., from 6 – 24 months, depending on the country. The longer time horizon provides more of a cushion for the economy, particularly since the time horizon of the health crisis remains unclear.
Furthermore, while each individual government’s fiscal response has provided emergency lifelines to workers, the countries in the European Union are in talks to create an even more coordinated effort and expand fiscal stimulus to countries within the Union. The European Commission, which is the governing body of the European Union, is negotiating a plan to raise $841 billion by selling bonds backed by all 27 members to tackle the largest post-war crisis facing the region. The Commission is still in negotiations and the fiscal stimulus package is expected to be voted on in mid-July. While not a guarantee, this is the first time leaders of the European Commission have come together in a coordinated fashion since the “infighting and procrastination that marked leader’s response to the eurozone debt crisis that began in 2010.”[3] This type of coordinated effort will go a long way to stem some of the financial impact that has arisen from the health crisis.
Early signs are showing that these fiscal measures as well as the public health measures enacted to stem the spread of the virus (i.e. stricter lockdowns, contact tracing, and face coverings) are providing support, particularly in Europe, as the region slowly reopens its economy. Unemployment (chart above) has been fairly steady, new cases are almost eight times lower than in the U.S. at 4,000 per day versus 30,000 in U.S.[4], Purchasing Managers’ Index (PMI) Composite Surveys have been rebounding, while confidence and retail spending are stable.
However, Europe and the UK are still highly dependent on trade. We anticipate there will be some headwinds to growth from the increasing momentum for deglobalization heightened by the crisis and the trade tensions with the UK and the U.S. In addition, rising fiscal debt burdens globally will put pressure on long-term growth. However, in the near-term, Non-U.S. Developed markets appear to be, on a relative basis, weathering the economic fallout from the global pandemic rather well.
It has been a long time since Syntrinsic had much positive to say about economic or market opportunity in the Non-U.S. Developed part of the world. And while we recognize there remain long-term obstacles to economic growth in these countries, the pandemic could serve as an unexpected catalyst for improved opportunities going forward.
[1] The United Kingdom’s decision in 2016 to remove itself from the European Union
[2] U.S. Bureau of Labor Statistics, June 6, 2020
[3] NYT, “Europe Finally Got the Message: Leaders Act Together on Stimulus”
[4] The Graphic Truth: Two different pandemics – EU vs US, Source: John Hopkins University