…uncovering the revival of Europe’s peripheral markets.
By: Sandrine Soubeyran and Sayad Reteos Baronyan
Key takeaways:
- The NextGeneration EU (NGEU) funding, the Recovery and Resilience Facility (RRF), is providing a significant fiscal boost to the Euro area economy and underpinning the recovery in financial markets, but the impact on financial markets and the economy diverges between EU nations, with the size of RRF allocation and financial market composition being significant factors
- Both Spain and Italy, as some of the largest NGEU recipients and among Europe’s largest economies, have seen a significant recovery in their financial market performance since 2022
- Italy has led the outperformance in equity and bond markets over the 10-year period, while strong gains were only evidenced in Spain’s investment grade fixed income market, due to its large exposure to financials
- Germany’s financial market performance has been more closely aligned to its weak economy and underperforming markets, than say Italy, whose economy has also been weak, but the broader composition of its financial market and emphasis on rate sensitive sectors have been a greater benefit compared to Spain and Germany
- Equity valuations are better in Spain than Germany and Italy, especially if taking out financials from the calculation, in line with its stronger growth prospects
- Spain’s economic growth is set to surpass Italy and Germany in 2024-25, even if both are expected to see a recovery in 2025
- The extra growth from the RRF injection appears to be helping to plug some of the vast shortfall in Italy’s public finance, which resulted from the generous ‘Superbonus’ home renovation tax benefits. In Germany, the more modest EU grants appear to be keeping the country from contracting further, with 2024 expected to be another year of flat to negative growth
Points of differentiation:
This paper provides valuable and unique insights into the structural differences and investment opportunities within European markets.
It shows the RRF funding is providing a significant fiscal boost to the Euro area economy and underpinning the recovery in financial markets, but its impact on financial markets and the economy diverges between EU nations, with the size of the RRF allocation and financial market composition being significant factors.
It highlights the benefits of EU markets, which have large/dominant exposure to financials, like Spain and Italy, and higher exposure to Technology, like Germany’s equity market.
The analysis also shows how Germany’s financial market performance is more closely aligned to the performance of its economy, than say Italy, whose economy has also been weak, but the broader composition of its financial market and emphasis on rate sensitive sectors have been a greater benefit compared to Spain and Germany.
The findings show that equity valuations are better in Spain, especially if taking out financials from the calculation, in line with its stronger growth prospects in 2024-25 compared to Italy and Germany.
What does our research mean for investors?
For investors, this research underscores the differentiated opportunities and risks within the Eurozone, shaped by the interplay of fiscal stimulus, market composition, and economic growth dynamics. Here’s what it means:
Focus on Peripheral Markets with Tailwinds from RRF Funding: Spain and Italy, as major beneficiaries of the NGEU Recovery and Resilience Facility, are experiencing significant fiscal boosts that support their financial markets. Investors could explore opportunities in these markets, particularly in sectors and assets benefiting from targeted stimulus.
Ex-Financials in Spain have better valuations compared to Italy: Italy’s strong performance in equities and bonds over the past decade highlights its relative resilience. Meanwhile, Spain’s equity valuations—especially excluding financials— reflect stronger growth prospects.
Germany Presents Challenges Amid Economic Weakness: Germany’s markets, closely tied to its lacklustre economy, offer fewer opportunities relative to Spain and Italy. The modest fiscal injection has provided a buffer against outright contraction, but growth prospects remain subdued, making Germany less compelling for growth-focused investors.
Sector-Specific Strategies May Outperform: Rate-sensitive sectors in Italy and the financial-heavy fixed income market in Spain have outperformed. Investors could tailor strategies to capitalise on these sector-specific dynamics while being mindful of concentration risks.
Prepare for Divergent Growth Dynamics in 2024–25: Spain is expected to lead Eurozone growth in the coming years, outpacing both Italy and Germany. Investors might consider positioning for this growth through Spanish equities and growth-sensitive sectors.
Risks from Public Finance Strains: Italy’s public finances remain under pressure, even with RRF injections helping to bridge fiscal gaps. While this does not yet pose an immediate risk to financial markets, it could impact long-term stability and should be monitored closely.
NOTES:
What is the Recovery and Resilience Facility (RRF)?
The Recovery and Resilience Facility (RRF) is a key component of the European Union’s NextGeneration EU plan. The programme was launched to address the impact of Covid in the Eurozone, and, later, the dependence on fossil fuels during the energy crisis in 2022. It combines reforms and public investment, with the Recovery and Resilience Facility (RRF) at its core funding, and addresses the green and digital transition.
How will the RRF funding work in practice?
The EU issues a mixture of EU-Bonds, EU-Bills and NextGeneration EU Green Bonds (~30% of the RRF funding). Repayment of EU borrowing allocated to NGEU is expected to start in 2028 and will take place over a 30-year period, until 2058. The loans will be repaid by the borrowing EU member states, while the grants will be repaid by the EU budget, therefore constituting genuine fiscal stimulus, since it will fund spending without increasing the debt or deficit ratios for the purposes of the stability and growth pact. Meanwhile, the EU loans are to replace, but not increase, an equal amount of deficit-financed spending by member states, allowing Spain and Italy as primary borrowers to access the higher AA/AAA EU credit quality rating, and a lower cost of funding.
Research article originally published on December 11, 2024 on FTSE Insights blog
PHOTO CREDIT : https://www.shutterstock.com/g/Harumana+SUN
VIA SHUTTERSTOCK
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