This is a big euro symbol.[i] Photo by Getty Images/Bloomberg.
Thursday, the eurozone released its preliminary or “flash” Q2 GDP reading, with the aggregate data showing no contraction in the quarter. But the aggregate also showed no growth, and this was the media’s central focus. These ”flash” releases aren’t exactly chock full of details one might want to perform a meaningful analysis of what drove the slowdown, but they give some high level numbers. And many in the punditry don’t need much more than that to jump to conclusions. In this case, they jumped to fear for Q3 due to increased sanctions on Russia and the still-tense situation in Ukraine. Others fear renewed recession generally and the potential for a lost decade a la Japan—calling for big ECB actions to head off a protracted slump. But these data don’t show much of an impact from the Ukraine situation on the eurozone economy. And the evidence a long-term slump looms in the eurozone is flimsy. In our view, this is mostly an example of the slow eurozone recovery overall and not something new and terrible for investors to be concerned about.
Behind the stall were -0.2% q/q contractions in two of the four biggest eurozone economies, Germany and Italy, and a flat France.[ii] Spain partly offset, growing +0.6% q/q. First, let’s be clear: This is not the shocker some folks argued. Analysts expected eurozone growth of 0.1% in Q2. So while 0.0 may remind you of the sheer magnitude of Blutarsky’s failure in Animal House, it’s actually a pretty darn small miss. Germany, too, was expected to contract -0.1%, as most analysts acknowledged that an unusually warm spring pulled some construction activity forward into Q1. France’s second straight flat read was also only one tenth of one percentage point below analysts’ estimates. And besides, all quarter long some pundits have pointed to France’s contractionary Purchasing Managers’ Index readings and presumed this time they’d show up in falling GDP. Flat isn’t much to celebrate, but it doesn’t seem very ill to us either.
Now, right about here is where we would ordinarily start diving deep into data and showing you what caused the dip and whether we think those factors are lasting. But as we’ve noted, flash GDP is called “flash” because the statistics gurus publish it really, really fast (in their terms—this is all relative, mind you). They accomplish this feat of blazing speed by using an incomplete series of data, and in this case, that means details regarding economic activity in the eurozone are absent. There isn’t that much here to actually analyze.
But what is here doesn’t support the notion that Ukrainian tensions had a material impact. Take Germany, for example. According to Destatis, Germany’s Federal Statistics Office, the decline was mostly attributable to that warm weather. But another factor was net trade—import growth outpaced export growth. Headline GDP growth counts net trade, so trade detracted even though both categories grew. There is no real sign big changes in Russia’s 3.8% share of German trade caused this dip, and that’s including a 15% y/y drop in German exports to Russia.[iii] Besides, if the Ukraine and Russia were a huge economic risk to the region, why did Latvia, Lithuania and Estonia all grow just fine?
It seems much of the fear of Ukrainian tensions weighing on Germany and the eurozone is tied to a recent sharp fall in a German confidence survey, the ZEW Economic Confidence survey, which fell 18.5 points in August to its lowest read since December 2012—and many claimed the fall reflected Germany’s vulnerability to Ukraine. But we wouldn’t put a lot of stock in the predictive power of confidence surveys. Investors’ confidence is often heavily influenced by recent stock market movement—and past stock market moves don’t predict future. The ZEW gauge was in negative territory and falling for much of 2012, yet the MSCI Germany rose 30% that year.[iv] The gauge posted its steepest fall that year in June 2012. The year’s global correction ended June 4. The drop in confidence more likely reflected recently falling prices than it did predict them.
The other big fear is the potential lost decade, a Japan-like period of deflationary stagnation. Now, never mind that there is no deflation—but rather, cheaper energy and food. Some pundits speculate the future looks very dim for the eurozone, barring more radical action by the ECB. They point to Italy, with its 11th GDP contraction in the last 12 quarters in Q2. They point to Greece, still in recession (albeit a slower recession), Portugal’s banks, and France as the supposed “sick man of Europe.”
But for investors, there are a few points to consider here. One, the outlook over the very long term is unknowable, and stocks likely won’t reflect it at all. Two, the recent trajectory of growth in the last quarter, year or six years (Greece) isn’t a roadmap for what’s ahead. Economies are not subject to laws of physics, so there isn’t much reason to simply project forward the current slow-go trend. And three, the primary cause over the last few years seems to be bank deleveraging.
Since the financial crisis, eurozone Financials have slashed lending by around €4.3 trillion. That exceeds Ukrainian GDP—times 12. For this very reason, eurozone corporations seem set on making a sort of a structural shift in how they finance growth. With ECB stress tests due in October, it would not be surprising if banks were slashing lending even further today. After all, the ECB has telegraphed its intentions to wind down undercapitalized banks (see Banco Espirito Santo), possibly bailing in creditors. Hoarding capital is a wise move.
The more capital banks hang onto, the more likely Europe’s small- and medium-sized companies are forced to either dial back plans or seek other means of financing. Historically, banks have been the primary source of business financing in Europe—their bond market for smaller and medium-sized firms isn’t nearly as robust as the US’s. However, that is now shifting some, possibly due to the tight bank credit of recent years. European high-yield issuance is up markedly, reaching a new all-time high earlier in 2014. But that record is only $120 billion, too small to have much impact.
Now, if all of this eurozone-deleveraging, back-and-forth recovery spiel sounds like old news to you, that’s because it is. But there isn’t anything in recent data that indicate that story is inaccurate. And this is yet another reason why the eurozone’s issues likely do not materially weigh on stocks, much as growth may be slow, sluggish or non-existent.
[i] The countries that use this big euro symbol are: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.
[ii] Germany’s dip met with the rather curious headline, “German Economy Shrinks for First Time Since 2013.” Which is factual, of course, but weird considering only two quarters of 2014 have elapsed. That “Since 2013” just doesn’t seem all that meaningful. Now if they had written it was the first since Q1 2013, that would be accurate, but not as entertaining to us.
[iv] Source: Factset, MSCI Germany total returns (in Euro) and ZEW Economic Confidence Index, 12/31/2011 – 12/31/2012.