Economic outlook – Eurozone recovery continues

Eurozone recovery continues on track

During September, all of the attention was on the Fed. The US interest rate saga is becoming lackluster and US economic fundamentals are in total contradiction with overall stock market performance. During the last 3 years, the performance improvements we’ve seen have mostly been driven not by higher or better economic activity, but rather by increased accounting efficiencies and share-buyback programs. 

In the confusion that reigned after the Fed announcement, the news about Volkswagen’s cheating on CO₂ emissions standards and the liquidity squeeze at Glencore were like earthquakes with a magnitude of 9.0 on the Richter scale for the market. While the former represents another chapter in the economic war between the US and Europe (where Europe has lost every battle so far), the latter reflects the dangers of a highly geared investment strategy. The fact that a full economic recovery in Emerging Markets remained elusive proved to be the little grain of sand in Glencore’s highly efficient machinery.   

Ever since the 2008 financial crisis, global growth rates are much slower than in previous cycles. Surprisingly, strongly embedded growth factors such as more and stronger consumers no longer deliver the expected performance, mainly because many economies are now experiencing “Uber-isation” (whereby many individuals are generating income through Internet-based sharing services and not declaring them for taxation as required; well known examples include Airbnb and Uber.) This is particularly true for Asia and LatAm where the growth experienced during the last twenty years was based on infrastructure projects and on foreign commodity demand. In the US where the service industry is more advanced than elsewhere, the top 1% in the industry enjoys the benefit of an overall growth rate in the region of 7 – 8% per annum, about 80% of the population is exposed to stable conditions similar to those in Europe, while the remaining 19% is exposed to shrinking growth opportunities.

In recent years, downward revisions of growth in emerging markets, led by China, have become a familiar pattern. Yet, there are small signs that stabilization is occurring. Therefore, the question – Which region, Europe or North America, is most immune to this lasting slowing trend – is warranted. Is it the more consumer and service driven market of the US, or is it Europe which benefits from lower energy and commodity prices as well as from a weaker euro which is beneficial for exports?

Statistics actually show opposing pictures for the US and Europe. Recent data suggest that the US economy grew by 2.2% in the first half of 2015, while in Europe, economic growth has averaged 1.5% in the past four quarters. While, unemployment remains relatively high across the euro-zone, the unemployment rate fell to 5.1% in the US in the month of August. Yet, it is important to note that the US economic cycle is most likely close to the top while in Europe, the cycle is just about to start, therefore, offering a unique upside story.

Low commodity and energy prices, a prolonged period of low interest rates, the EUR/USD parity dealing close to its fair value, a QE program which is expected to extend into 2018, positive balance sheets at the household level, and less dependence on emerging markets (EM) than the US, all bode well for positive European stock market prospects.   

Risks to the downside: In Europe, social and job security are relatively strongly embedded into the day-to-day fabric of society.  Given this, economic reforms are more difficult to conduct than elsewhere. This does not encourage European economies to kick-start. More importantly, in the recent 2011 and 2013 transition periods countries such as France and Italy failed to conduct, , fundamental labor market and pension fund system reforms. If these concerns are not addressed quickly, it will inevitably result in a two-tier system, with Germany, Spain, the Netherlands, the Nordic countries, and Poland on the one side, and France, Italy, and Greece on the other.