Eurozoom!

A year ago, media looked at the eurozone economy skeptically. Yes, the 19-member currency bloc was growing—but what if growth stalled? Some big unknowns loomed, too. Headlines fretted over 2017 political developments and whether anti-EU populists like Geert Wilders of the Netherlands would seize power and destabilize order. Or what the ECB—allegedly responsible for growth—would do next with its monetary policy. Few experts thought the eurozone would be at the forefront of the global economic expansion. Yet on a year-over-year basis, that is exactly what happened: As of Q3 2017, the eurozone’s 2.5% growth rate leads the US (2.3%), UK (1.5%) and Japan (1.6%).^[i] The data continue showing an expansion on firm footing and one that looks likely to continue for the foreseeable future—an underappreciated positive for eurozone markets.

Eurozone GDP rose 0.6% q/q in Q3, its 18^th straight positive quarter. All 11 reporting countries (as of December 5) grew, from powerhouse Germany to long-struggling Greece. While GDP is useful as a high-level economic snapshot, it also focuses on the past three months—not too meaningful for forward-looking stocks. However, more recent data like Purchasing Managers’ Indexes (PMIs) suggest the eurozone is ending 2017 on a strong note.

A quick primer: PMIs are monthly surveys tracking business activity across manufacturing and services. Purchasing managers report a spate of information like new orders, output, costs and employment, and survey compilers crunch the numbers. If the final number exceeds 50, a majority of businesses grew (and vice versa if the figure is under 50). While PMIs aren’t perfect—they are rough sketches that don’t indicate the magnitude of growth (or contraction)—they can provide a quick and timely estimate.

IHS Markit’s November PMIs were strong throughout the eurozone. Its eurozone composite PMI climbed to 57.5 from October’s 56.0, notching a six-and-a-half year high. The services PMI rose to 56.2 (also one of the strongest readings in more than six years), but manufacturing PMI grabbed the lion’s share of attention after hitting 60.1. That marks the second-best reading in the survey’s 20-year history. While manufacturing is a smaller part of the services- and consumption-heavy eurozone economy, its strong growth—and positive prospects, with new orders also strong—highlight the breadth of the eurozone expansion.    

For stocks, though, what matters most is the future, and in particular, the next 12 — 18 months. Data look solid on that front, too. The Conference Board’s Leading Economic Index (LEI) is one of the most telling gauges about future economic growth. Historically, no recession has started when LEI is high and rising, as it is today: Eurozone LEI rose 0.9% m/m in October, its 14^th straight positive reading. Of its eight underlying components, the most forward-looking—the yield spread—remains a primary contributor. The yield spread indicates how profitable lending is for banks. The wider the spread, the more willing banks are to lend—helping businesses and households access capital more easily. As the ECB has noted, there are signs this is happening: Households and business lending have picked up over the past several months. 

Eurozone economic growth isn’t a secret, as some economists have acknowledged the overall breadth of the global expansion. However, doubts about its sustainability persist—especially with experts crediting the ECB for propping up the economy. Yet the data dispel this false narrative. Eurozone GDP started growing several quarters before the ECB launched its quantitative easing program and implemented negative interest rates. As investors start noticing the eurozone economy doesn’t depend on “accommodative” monetary policy, sentiment will likely warm and stir the proverbial “animal spirits.” In our view, this tailwind has plenty of life to propel eurozone markets higher—a fundamental reason we remain bullish toward eurozone stocks.