After a brief period of stabilization, our measure of global credit impulse has plummeted. This does not bode well for European equities.
The credit impulses in all three major economies – the euro area, the U.S. and China – are now negative, albeit very slightly in the case of China. This is the first time in three years that all three components have been simultaneously negative. And after hovering at a point of inflection the combined credit cycle indicator has lurched down again.
For any open exporting economy, such as the euro area, the global credit cycle is much more important than the domestic credit cycle. This is because the sales and profits of large European companies are sourced globally, not just from Europe.
According to our European Investment Strategy service, a weakening credit cycle normally precedes a poorer return/risk trade-off for risk assets such as equities – through lower returns and/or higher volatility. After their recent strong rallies, European equities seem vulnerable to any new downgrades to growth.
Hence, for short-term investors we advise against an absolute overweight position in European equities.