What Will The 'Japanification Of Europe' Mean For Investors?

Could European markets follow Japan in terms of becoming a low-growth, low-interest rate environments?

Jan Erik Saugestad, CEO at Storebrand Asset Management

There are many forces at work, but overall low growth and low interest rates are likely to go hand in hand.

There are many reasons for this, but demographics are certainly an important element.

The combination of lower growth in standards of living and lower growth in the population has a double impact on growth.

As a result, western Europe is likely to experience low growth and low interest rates for a long time, similar to the experiences of Japan.

A low interest rate environment over a prolonged period may lead to misallocations of capital, which in turn could result in not only low growth but also in losses.

Over time, the risk premia in all asset classes could be compressed even though the underlying risk may be increasing. This should be a key concern for investors.

How concerned should investors be that such an environment might last for a prolonged period?

David Riley, chief investment strategist at BlueBay Asset Management

Low growth and ultra-low interest rates will characterise European markets until policy-makers wake-up to the necessity of economic reform and fiscal activism that is necessary to boost growth and inflation expectations.

The political debate is shifting towards more pro-growth economic and fiscal policies, but at an achingly slow pace.

Japan proved not to an outlier, but a forewarning of lower for longer interest rates in wealthy but ageing, indebted and high saving European economies.

Even in the more dynamic United States, the prospect is for real interest rates to hover around zero rather than between the 1% to 2% range prior to the Global Financial Crisis.

What would such an environment in Europe mean for global markets? Would there be any risk of contagion?

Donny Kranson, portfolio manager at Vontobel Quality Growth

A low growth environment in one country is not good for others. Countries, despite recent increases in tariffs, still trade with one another.

In addition, a low interest rate in one country pushes up the currency of others on a relative basis, hurting exports and manufacturing jobs.

It does not mean other parts of the world would match the anaemic growth rates, but it is not helpful.

From a demographic and development perspective, emerging markets and the US should have faster growth.

However, savers looking for returns in unfamiliar markets can lead to increased volatility.

What would such a market environment mean in the context of asset allocation?

Tatjana Greil-Castro, portfolio manager at Muzinich & Co

While we have seen yield curves become flatter, the European curve is steep compared to that of Japanese government bonds and US Treasury curves, which are quite flat.

The steepness in the European yield curve suggests we are likely to stay in this environment for a long time and suggests that the long end in Europe has room to rally.

Asset classes we believe could benefit from this include longer duration fixed income.

In terms of positives, the low rate environment is resulting in a lower cost of funding for issuers.

From a negative perspective, investors are being pushed further down the risk spectrum in their hunt for yield, arguably without being compensated accordingly.

In a low yield environment, volatility could rise, which in turn is likely to have a greater impact on total returns, given the low-yielding starting point.

What if anything can or should be done to re-stimulate growth in the European market?

Gero Jung, chief economist at Mirabaud Asset Management

From a market point of view, we do believe the European Central Bank is likely to act further. We expect a cut in the (already negative) deposit rate in September, as well as the introduction of a tiered banking reserve system.

We expect the announcement of another QE purchase programme in the fourth quarter, with asset buying starting in Q1 next year.

In the short term, the announcement of another round of asset purchases will be a positive one, though the longer-term effects are less clear.

Monetary policy has only a limited impact on issues that affect longer-term growth, like productivity.

For this, some serious structural reforms would have to be undertaken. With ever more monetary accommodation, and European governments getting paid to borrow, authorities have even less incentives to go into this direction.