UK Bulls as Eurozone Inches Out of Recession

  • Bullish position on the UK (etf: EWU) and Germany (EWG) remains.
  • Eurozone fundamentals inching higher; investor sentiment improving on weak comps. On a relative basis the Eurozone is well below its historical growth average and churning only modestly higher as deep structural imbalances and the lack of credit drag on growth.
  • We underline the significance of Eurocrat and ECB resolve to lend support to the region and markets (at all costs), which, along with marginally better data, should continue to support Eurozone capital market performance.

 

UK’s Island Economics


In support of our fundamental bullish call on the UK economy since our June 11th European update presentation titled “Where Does Europe Go From Here”, yesterday the UK printed a strong Retail Sales figure of 3.0% in July year-over-year (exp. 2.4%) vs 1.9% JUN.

 

The print and the down move in the FTSE100 yesterday prompted us to add the UK via the etf EWU to our real-time portfolio positions on the long side.

 

UK Bulls as Eurozone Inches Out of Recession  - zzz. uk ftse

 

UK Bulls as Eurozone Inches Out of Recession  - z. uk retail and IP

 

Our outlook on the UK is data and price dependent and hasn’t changed: we expect to see outperformance from the UK economy versus many of its European peers due to its decision to issue austerity earlier in the fiscal consolidation cycle. We are now seeing stronger signs of improved consumer sentiment, and expect PMI readings to maintain their level above the 50 line (expansion) into year-end. Beyond retail sales, industrial production and housing figures have improved year-to-date, and while wage volatility and sticky stagflation persist, we view reductions in the saving rate as another indicator of improved sentiment.  Further, we’re bullish on the changing of the guard at the BOE to Mark Carney – while it’s up for argument on just how effective tying monetary policy to the unemployment rate is, we like the Bank’s move towards a more transparent state to better manage and guide expectations.

 

UK Bulls as Eurozone Inches Out of Recession  - z. uk cpi

 

UK Bulls as Eurozone Inches Out of Recession  - z. uk house prices

 

UK Bulls as Eurozone Inches Out of Recession  - z. uk savings rate

 

 

Eurozone Inching Higher

 

The big news this week was a better-than-expected first print of Q2 GDP out of the Eurozone, a follow-on to improving fundamental data out of the Eurozone in recent weeks.

 

The Eurozone’s +0.3% Q2 GDP rise marked the end of an 18 month recession (cheer!), and the figure beat our expectations for only modest improvement over Q1 (consensus was at +0.2%), especially in a quarter that was hampered by bad weather (including serious flooding throughout central Europe), continued misdirection in economic leadership from France’s Hollande (France has the second largest economy behind Germany in the Eurozone), and continued political strife in Italy, Spain, and Portugal.

 

UK Bulls as Eurozone Inches Out of Recession  - z. eurozone gdp

 

Clearly the data is looking better.  Germany and France also beat Q2 GDP expectations. Germany reported growth of +0.7% Q/Q (+10bps above expectations) versus 0.0% in Q1 and France rose +0.5% Q/Q (+30bps above expectations) vs -0.2% in Q1. Add to this performance PMI figures that have improved across the region over the last 3-5 months (reaching over the 50 line in the last 1-2 readings) and improvement in sentiment readings across the core and periphery.

 

UK Bulls as Eurozone Inches Out of Recession  - z. pmis

 

Risk Spreads are dropping to new lows. Also, 10YR Spanish and Italian bonds are trading at their tightest spreads over comparable German paper in more than two years at ~252bps and 235bps, respectively.

 

UK Bulls as Eurozone Inches Out of Recession  - z. 10 spreads

 

 

Not All Is Rosy


What’s our read?  While there’s optimism to be had on improving data, GDP was still down -0.7% year-over-year in Q2 and we expect a very slow churn higher in Eurozone GDP in the balance of 2013. Certainly GDP will remain well below the pre-crisis average of 2.1% (since 2000) as the region hits the reset button on standards of spending and lending as budgets are readjusted at the government and household levels.  We maintain our call for 2013 GDP between -0.8% and -0.6% year-over-year.


Beyond struggling to reset spending and lifestyles habits, here are some significant hurdles that we expect will continue to weigh on Eurozone GDP:

  • The slim availability of credit, in particular to the small and medium sized businesses, the core drivers of growth and employment (see chart below on ECB Loans to Non-Financial Corporations and Households as proxy—at or near all-time lows)
  • Diminished credit quality of banks, especially across the periphery, as they report increasing non-performing loans
  • Further bank write-downs of non-performing assets
  • Labor market reforms slow to enact or institute at all
  • A protracted unemployment overhang, especially youth unemployment across the periphery, that will limit consumer spending and confidence
  •  Political uncertainty, in Italy, Spain, and Portugal, to weigh on budget reforms and confidence

UK Bulls as Eurozone Inches Out of Recession  - z. ecb lending

 

To throw out a couple anecdotes from the media stories we’ve recently come across that paint a still subdued outlook, we include:

  • The WSJ reported that auto sales in Europe are so bad that less than half the factories in the region operate at the minimum 75% of capacity needed to break even. It said that those operating below that level are mostly located in Italy, France, and Spain whose economies have been hit by the crisis. The article noted that governments in Western Europe are worried about seeing more workers join the ranks of the unemployed and that unions are aggressively protecting jobs, while the courts have also been sympathetic. The paper said that because of this, auto makers are losing billions of euros a year by retaining workers and factories they no longer need.
  • A poll by ING-DiBa AG and the University of Hohenheim shows that only 17% of Germans believe that the worst of the Eurozone crisis is over, while 91% think that the crisis will still go on for a long time. Only 10% of Germans believe that politicians are being honest with citizens regarding Eurozone issues.

 

Concluding Thoughts

 

Our call remains that into Q4 we expect European PMIs to hover around the 50 line (ups and downs) but not to show a material breakout given the very weak structural issues that we do not see inflecting materially over the intermediate term, including weak credit conditions, high unemployment, alongside political uncertainty at the country level – Italy, Spain, and France in particular.  We continue to be fundamentally bullish on German and the UK equities, so should we see any outperformance from PMIs, we think it could come from these two countries.

 

As it relates to the capital markets, we think a much larger force versus marginal improvement in fundamental data is the political resolve of the Eurocrats and Draghi to lend fund if needed (back-pocket OMT ready) and prevent any country from leaving the Eurozone, which we think can continue to stabilize and push markets higher. Already we’re seeing domestic and international investors become increasingly confident in Draghi’s heavy hand and buying distressed asset, for example housing in Spain and bank debt across the periphery, as the EU banking system slowly continues to heal.      

 

Enjoy the weekend!

 

Matthew Hedrick

Senior Analyst


Another French Revolution?

"Don't be complacent," writes Hedgeye Managing Director Neil Howe. "Tectonic shifts are underway in France. Is there the prospect of the new Sixth Republic? C'est vraiment possible."

read more

Cartoon of the Day: The Trend is Your Friend

"All of the key trending macro data suggests the U.S. economy is accelerating," Hedgeye CEO Keith McCullough says.

read more

A Sneak Peek At Hedgeye's 2017 GDP Estimates

Here's an inside look at our GDP estimates versus Wall Street consensus.

read more

Cartoon of the Day: Green Thumb

So far, 64 of 498 companies in the S&P 500 have reported aggregate sales and earnings growth of 6.1% and 16.8% respectively.

read more

Europe's Battles Against Apple, Google, Innovation & Jobs

"“I am very concerned the E.U. maintains a battle against the American giants while doing everything possible to sustain so-called national champions," writes economist Daniel Lacalle. "Attacking innovation doesn’t create jobs.”

read more

An Open Letter to Pandora Management...

"Please stop leaking information to the press," writes Hedgeye Internet & Media analyst Hesham Shaaban. "You are getting in your own way, and blowing up your shareholders in the process."

read more

A 'Toxic Cocktail' Brewing for A Best Idea Short

The first quarter earnings pre-announcement today is not the end of the story for Mednax (MD). Rising labor costs and slowing volume is a toxic cocktail...

read more

Energy Stocks: Time to Buy? Here's What You Need to Know

If you're heavily-invested in Energy stocks it's been a heck of a year. Energy is the worst-performing sector in the S&P 500 year-to-date and value investors are now hunting for bargains in the oil patch. Before you buy, here's what you need to know.

read more

McCullough: ‘My 1-Minute Summary of My Institutional Meetings in NYC Yesterday’

What are even some of the smartest investors in the world missing right now?

read more

Cartoon of the Day: Political Portfolio Positioning

Leave your politics out of your portfolio.

read more

Jim Rickards Answers the Hedgeye 21

Bestselling author Jim Rickards says if he could be any animal he’d be a T-Rex. He also loves bonds and hates equities. Check out all of his answers to the Hedgeye 21.

read more

Amazon's New 'Big Idea': Ignore It At Your Own Peril

"We all see another ‘big idea’ out of Amazon (or the press making one up) just about every day," writes Retail Sector Head Brian McGough. "But whatever you do, DON’T ignore this one!"

read more