- Eurozone fundamentals inching higher, including stronger PMIs; 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.
- Bullish position on the UK (etf: EWU) and Germany (EWG) remains.
Yesterday, preliminary August PMIs for the Eurozone, Germany, and France were released, and short of France’s Services figure that contracted month-over-month (and is below the 50 line at 47.7), the European aggregate and Germany numbers are showing 2 year highs, resting above the 50 line.
Eurozone PMI Manufacturing 51.3 AUG (exp. 50.7) vs vs 50.3 JUL
Eurozone PMI Services 51 AUG (exp. 50.2) vs 49.8 JUL
Eurozone PMI Composite 51.7 AUG (exp. 50.9) vs 50.5 JUL
Germany PMI Manufacturing 52 AUG (exp. 51.1) vs 50.7 JUL
Germany PMI Services 52.4 AUG (exp. 51.7) vs 51.3 JUL
France PMI Manufacturing 49.7 AUG (exp. 50.3) vs 49.7 JUL
France PMI Services 47.7 AUG (exp. 49.2) vs 48.6 JUL
What’s Our Read?
Our European call for fundamentals to stabilize remains underway. While we expect protracted below trend growth in the region, the Eurozone Q2 GDP print of +0.3% Q/Q ushered in an end to the 18 month recession, and we’re seeing positive follow-through on the data. Germany is leading the growth charge at +0.7% Q/Q with strong export and import figures (+2.2% and 2.0%, respectively), and we continue to like UK fundamentals – today in a second estimate, Q2 GDP was revised 10bps higher to +0.7% Q/Q.
Yet while there’s optimism to be had on improving data, Eurozone 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 (we are not getting over our ski tips). 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
- 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 (Berlusconi remains the lynchpin), Spain, and Portugal
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 would expect it to 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.