Euro, Italian Bank Shares and Greek Government Bonds are En Vogue for 2018 - UBS

Robust global growth and loose financial conditions support continued balance sheet repair and faster recovery on the continent. 

European currencies, Italian banks and Greek government bonds are all top investment ideas for 2018, according to strategists at UBS, as the Eurozone economic recovery is set to deepen and broaden out during the year ahead.

Global inflation is set to rise at a modest pace during the year ahead, but will remain low in historical terms and afford central banks the space to tighten monetary policy at a steady and sustainable pace.

“We see opportunity in moving up the risk spectrum, positioning for a steeper curve, and EUR strength,” say Yianos Kontopoulos and the macro strategy team at UBS.

A robust global backdrop should nurture the conditions necessary for Eurozone economies to continue repairing their balance sheets, while the passing of Italy’s elections, if all goes according to expectations, could create scope for the political concerns of recent years to fade further from view.

“We have been bullish the euro and European assets during the past few years, arguing that markets have been underappreciating the strong underpinnings of European growth and overly concerned with political/structural issues. Our bullishness continues into 2018,” says Kontopoulos.

Above: EUR/USD shown at weekly intervals. Captures 2017 rally.

The Euro has risen by nearly 13% against the Dollar in 2017 and by 4% against the Pound, making it a top performer in the G10 currency basket, much to the plight of UK based individuals with liabilities overseas.

This was after the economic recovery on the continent was shown gathering pace and the European Central Bank set itself a course to exit its quantitative easing (bond buying) program. Eurozone growth is forecast to comfortably exceed the 2% threshold for the current year and to continue apace in 2018.

Above: Euro-to-Pound at weekly intervals. Captures Brexit referendum and subsequent trading.

“The contribution of investment to growth is now approaching pre-crisis trends, having lagged substantially for a number of years. Importantly, investment has significant room to return to pre-crisis trend levels relative to any other demand component,” says Kontopoulos.

A further pickup in business investment should help the Eurozone recovery deepen to include sectors of the economy not previously touched by the upturn, as well as countries that were previously left out in the cold.

“The breadth of the recovery is shown by substantial convergence between growth rates across the region, and this should make the recovery more durable,” Kontopoulos adds. “The rebound in the periphery should continue given the significant spare capacity that has built up, and the recent sharp pick-up in exports will act as an additional tailwind as it persists.”

Further tailwinds, which are positive drivers of asset prices, could also accrue to the Euro area thanks largely to past monetary policy action by the ECB.

“It is worth noting that European financial conditions only shifted well into accommodation around 2014, and this should continue to provide a tailwind for growth and markets in the region,” says Kontopoulos.

Among others, Greek government bonds, Italian bank shares and currencies like the Czech Koruna and Polish Zloty could all make good investment ideas against this backdrop. That’s not to mention the Euro, which UBS forecasts will rise to 1.2500 against the Dollar by end-2018 and 0.9500 pence against the Pound.

Above: US Dollar relative to the Czech Koruna at weekly intervals. Captures 2017 CZK strength.

“Our European economists expect gross fixed capital formation in the Euro area to accelerate to 4.4%, from 3.8%. This should support continued recovery in European import volumes, and help prospects for Central and Eastern European FX appreciation,” says Kontopoulos.

UBS advocates buying the Zloty and Koruna relative to either the Dollar or Swiss Franc. Buying the Czech Koruna was also one of the bank’s top 2017 trades and returned 5.6% during the year to date.

Above: US Dollar relative to the Polish Zloty. Captures 2017 Zloty strength.

“Political risks are abating as Greece's government is becoming more involved with Eurozone institutions,” says Kontopoulos. “On the debt front, Greece has already been granted substantially larger debt relief by its official creditors than is typically appreciated.”

The bar for positive surprises, relative to market expectations, with Greece’s continued restructuring is low.

“We like being long the short end of the GGB curve as an attractive way to position for further normalisation of the hefty risk premium still embedded in GGBs and the Greek curve,” says Kontopoulos.

Meanwhile, high interest rates in the Mediterranean country mean Greece is a good “carry trade”, which involves borrowing a low-interest currency to buy high interest assets.

“For the last few months investor focus has been on the general election due to take place in Q1/Q2 2018,” says Kontopoulos. “At the same time, however, the Italian economy accelerated significantly, with y/y growth in Q3 at 1.8% and sentiment indicators indicating that growth momentum remains strong into Q4.”

Kontopoulos says faster growth in Italy will have a positive spillover effect on Italian creditworthiness, borrowing costs and therefore, debt sustainability. This, and the passing of next year’s election, could help reduce the “still-elevated” risk premia attached to Italian bank stocks.

“Italian banks in particular offer an attractive opportunity in our view. Italian midcap banks (Banco BPM, UBI, BPER) have significantly underperformed European peers (by c. 10-18%) following the publication of the ECB and EC proposals on NPLs in October due to asset quality and regulatory risks,” says Kontopoulos.

The UBS team advocates buying the FTSE Italia All-Share Banks Index to gain exposure to an anticipated recovery in share prices across the sector.

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