There’s been a remarkable rally in European equities and the EURO STOXX 50 is up 20% since the lows in late September. Dollar-based investors have enjoyed an even bigger increase. I didn’t expect this rally and I wasn’t alone with most investors and analysts having been bearish of European equities on an absolute and relative basis. So, is this the return of a bull market or a rally in a bear market?
Much of the rally reflects falling gas prices – which is very good news for the region. Back in August when Russia turned off the gas, we said we needed a winter that was warm, wet, and windy. Warm to reduce demand, wet to fill up Norway’s reservoirs and windy to boost offshore wind. The chart in the video plots natural gas prices for next month delivery and even as we approach winter, prices have been falling. And there’s more to it than the weather. The futures price for December 2023 has fallen even further than December 2022.
So, what’s going on? First my two best friends, supply and demand have been at work and, as ever, people have underestimated them. Germany has filled its gas storage tanks. Supply of liquid natural gas (LNG) has been booming, especially from the US where President Biden chose not to further delay the reopening of the huge LNG terminal in Texas.
Germany’s energy price support scheme is a masterstroke even though it was announced late. They are subsidising prices, which supports overall economic activity, but only to the extent of 70% of last year’s usage for large industrial users and 80% for other businesses and households. The scheme therefore incentivises lower demand. German industrial production is already down 15% since the war in Ukraine with energy intensity down even more. There’s a big effort from German society to cut gas consumption irrespective of the price and I’m disappointed that we haven’t followed suit in the UK.
There are undoubtedly risks. There have been a series of attacks on NATO infrastructure this year including energy cables in Norway, the German rail network and on US airport websites. Some of these would have required specialist capabilities. The Svalsat cable in Norway is several hundred metres deep and if as many people believe, Russia was behind these attacks, they may have been practising for a more broad-based campaign. The invasion of Ukraine has not gone well for Russia, to put it mildly, but their attacks on the Ukrainian electricity supply have been very effective.
Some hawks in the intelligence community expect another energy price shock this winter with supplies to Europe from the middle east being disrupted. We hope they are wrong. Indeed, there is growing pressure in some quarters for Ukraine to accept a peace deal.
On the broader front, economic numbers have improved relative to expectations, and we suspect that consumers across the developed world will treat themselves to a good Christmas after covid disrupted the last two.
So will the rally in European equities continue? We think not. First, Europe’s consumers are facing a serious real income squeeze. Wages in the Eurozone are rising at 3% or so but inflation is in double figures. Consumers might just draw on their covid piggy banks over Christmas, but they will be forced to cut back in the New Year and as demand weakens further, margins will fall. It looks like we’ve seen a bear market rally in European equities rather than a prolonged upturn.