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The EU economy is up, volatility down and investors have figured this out

The London Stock Exchange.

Toby Melville/Reuters

If you just read the headlines, especially in North American papers, you might think Europe had plunged back into the Dark Ages. Immigration crisis, terrorist attacks, rising populist and neo-fascist parties, Brexit, ailing banks, gruesome youth unemployment – all that's missing on the horror front is the bubonic plague and Trump Towers in the capital cities.

The European atrocities are all true, to a degree, but what is also true is that the good news has been buried. Investors might take note. The European stock indexes are surging ahead and the markets' measures of volatility are running at low levels. The fear factor, in other words, has dissipated and investors who have figured this out are making a lot of money.

On Saturday, the European Union celebrates the 60th anniversary of the Treaty of Rome, the declaration that begat the European Economic Community, the granddaddy of today's EU. There is no doubt the EU is under stress. The celebrations, in Rome, come only four days before Britain triggers Article 50 of the Treaty on European Union, signalling the start of the formal negotiations to abandon EU membership. It comes as France, Germany and Italy gear up for elections that could theoretically install populist, Euroskeptic governments.

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To many investors, these events act as warning signs. Why invest in a region that is under stress, that seems to have lost its sense of purpose, that may not even exist in a few years as the nationalist forces storm the streets with their anti-EU and anti-euro placards? Since the 2008 financial crisis, betting against Europe – not for it – has stood fast as the winning trade. Indeed, at a Friday news conference in Rome, former Greek finance minister Yanis Varoufakis said: "The idea of Europe is in retreat and the EU is in an advanced state of disintegration."

But it may be time to change the bet – even if the EU, as Mr. Varoufakis believes, could fall apart. That's because reasons for optimism exist. The euro zone economy is stronger than advertised, and the nationalist and populist forces in some countries may have peaked, at least in the short term, and could even be in decline. Note that the Euro Stoxx 50 volatility index is running at its lowest level since 1999.

The result of the March 15 Dutch election no doubt contributed to the index's drop. In the months before the election, various polls gave Geert Wilders and his xenophobic, anti-Europe Freedom Party a good chance of winning the election. But polls are often dead wrong, as they were in last year's Brexit referendum and U.S. election campaign. Mr. Wilders placed a distant second and has virtually no chance of entering the coalition that will be formed by Prime Minister Mark Rutte's liberal-conservative party.

Meanwhile, in France, Marine Le Pen of the EU-hating National Front is expected to win the first round in next month's presidential election but get trounced in the second round against Emmanuel Macron, the polls say. In September's German election, Chancellor Angela Merkel could lose to Martin Schulz, the new Leader of the Social Democrats, but there is no scenario that would put the Euroskeptic, anti-immigrant Alternative for Germany party in power. Whether led by Ms. Merkel or Mr. Schulz, Europe's biggest economy will remain in staunchly pro-EU and pro-euro hands.

Italy is the wild card. An Ipsos poll published this week in the Corriere della Sera newspaper put Beppe Grillo's populist Five Star Movement (M5S) at 32.3 per cent of the intended vote. That's more than five points ahead of the ruling, centre-left Democratic Party. M5S insists it wants Italy to stick with the EU but vows to hold a referendum on the euro.

Support for the euro in Italy is sinking fast – the economy has made zero progress since the common currency was adopted in 1999. The question is whether Italy's exit from the euro would wreck both the euro and the EU. Given the awe-inspiring size of Italy's debt, worth 133 per cent of GDP, it could. But there is no assurance the referendum would go against the euro, and Italy's economy is on the mend – albeit slowly. The euro zone as a whole is bopping along rather nicely, and the hope among the established centrist parties is that economic growth and job creation, if they persist, will remove some of the populist parties' allure.

More evidence of the euro zone turnaround came on Friday, when the composite purchasing managers' index landed at 56.7 in March, its highest level in six years. Employment growth is running at its strongest pace in almost a decade. Euro zone GDP is expected to rise 1.8 per cent this year, according to European Commission forecasts, up from the previous estimate of 1.6 per cent.

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Investors are getting the message. Germany's DAX index is up 22 per cent in the past year. France's CAC 40 is up 16 per cent and Milan's FTSE MIB index has gained 9 per cent. According to the Financial Times, European stocks are still cheap in spite of their rise. The FTSEurofirst 300 trades at about 1.8 times book value, while the S&P 500 trades at 3.1 times.

Europe is recovering. Europe is cheap. A lot could still go wrong for investors – reform efforts are still pathetic and the polls in France could be wrong. But a lot is going right, too. Europe's risk profile, it appears, has been exaggerated.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More


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