This special guest commentary was written by our friend Daniel Lacalle.
Source: Marco Verch
European PMIs for July in the eurozone have shown how difficult it is to continue to believe in the mirage of growth that has been sold to us by Old Wall Street after Macron’s victory in France.
It is important to highlight the difference between a modest recovery and excess optimism, and in the euro area markets have gone from the first to the second without calibrating real hard data.
Both manufacturing and service PMIs continue in expansion mode, but France shows the weakness to which we are accustomed in an economy that promises reforms and has delivered stagnation for two decades, similar to what happens with Italy. More importantly, data from Germany also indicates a slowdown in this expansion.
This graphic courtesy of Morgan Stanley is very revealing. It shows the relationship between PMI indicators and GDP growth, and how data peaked in the past months.
There are other interesting variables that confirm the modestly positive but not euphoric tone of the European economy. Gross capital formation growth of 6% is positive, but the level of overcapacity in the European Union continues above 20%, therefore investment is still well below 2009 levels.
The investment expectations of the non-financial sectors point to an almost imperceptible capital expenditure (capex) increase in 2017, and certainly not above the average depreciation rate, which indicates that companies do not see an attractive environment for investment despite ultra-low rates, and too much of capital goes to real estate, construction and capital recycling (mergers and acquisitions).
The Eurozone increase in consumption and credit growth are decent but modest, yet well below the growth of the money supply, at least a third less. Not surprisingly, with 1.2 trillion euros of excess liquidity in the Eurozone, markets have opted for aggressive multiple expansion of stocks, well above the growth of adjusted real profits. That is why we must pay attention to the macroeconomic reality, to avoid falling into the trap of euphoria.
The latest Bank of America data reminds us that in Eurostoxx 600 almost 9% of companies can be considered “zombies”, ie their generation of operating profits does not cover the cost of interest payments, despite historically low-interest rates and huge liquidity. With a banking system that continues to accumulate almost 900 billion euros of non-performing loans, this is a combination that investors should not ignore.
Old Europe, therefore, continues to reveal its old problems: Overcapacity, companies with difficulties and an aging population that has more conservative consumption patterns. That is why we maintain our expectations for Eurozone growth unchanged for 2017 and 2018, and we expect confirmation in corporate earnings of a guidance for moderate improvement in margins and balance sheets.
Economies that are betting on structural reforms are leading growth, but we cannot ignore the fact that two of the largest economies in the eurozone, France and Italy, face enormous challenges that are unlikely to be solved betting that monetary policy will solve everything.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor note written by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is Chief Economist at Tressis SV and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap. This piece does not necessarily reflect the opinion of Hedgeye.
