Fisher Investments Editorial Staff
Across the Atlantic

The Eurozone’s Rolling Hills of Economic Improvement

By, 11/22/2013
Ratings303.733333

If you told the average investor, “The eurozone seems to be chugging along,” he’d likely gawk as though you’d grown another nose—sentiment on Europe is still in the doldrums despite improving economic reality. For example, eurozone data released Thursday were largely met with disappointment despite results largely alluding to continued economic growth. Most pundits seemingly fixated on the data, but other—probably more important moving forward—happenings in Greece, Italy and Portugal were announced, too. Again, some were good; some were bad. That just seems to be the lay of the land in the eurozone these days, but the good is often overlooked. The eurozone’s recovery is usually framed as fragile, weak, meager or even nonexistent. While we won’t argue it’s sharply improving, we would note even a faltering, uneven recovery is good for global stocks, as it likely exceeds what most expect—providing a positive surprise.

Thursday’s data seemed mostly a mixed bag, and many noted it as proof the eurozone remains sluggish. Yet November eurozone manufacturing expanded for the fifth month (51.5—readings over 50 indicate expansion), led by Germany (52.5). Germany’s Services sector (54.5) and business activity also accelerated, hitting 9- and 10-month highs. On the other hand, eurozone business activity softened some between October (51.6) and November (50.9), while French manufacturing and business activity contracted.

Still, the region’s overall numbers seemed fine. Weakness was primarily concentrated in France, where expectations were already near rock-bottom. Plus, bad news doesn’t necessarily outweigh the good—like when some sluggish areas didn’t prevent the eurozone’s overall growth in Q3. Moreover, with their heavy trade partners across the English Channel gaining steam—UK manufacturing orders hit an 18-year high in November—the eurozone’s future appears just fine.

Periodic economic data aren’t alone in suggesting the eurozone is improving. Even the Greek budget supports it. Yes, that Greece. Long considered the eurozone’s weakest link, Greece is in its sixth year of recession, during which it lost about 25% of its economic output. It has 27% unemployment and economic reform-related protests on most days ending in “y.” Even after two bailouts, totaling €240 billion, more help isn’t out of the question.

But—largely thanks to those bailouts, austerity measures and a watchful troika eye—Greece expects to achieve a primary budget surplus this year, ahead of schedule. Before debt obligations, Greek officials anticipate an extra €812 million on the 2013 ledger. Of course, Greece still needs to cut another €2 billion in spending to meet 2014 targets, but should the expected surplus materialize, the country may have a nice head start on them.

Italy is also making some progress despite political theatrics and deep gridlock. Its government plans to privatize up to €12 billion of state-held assets (as the EU’s budgetary bylaws require) to seek permission to boost spending by €3 billion. The Cabinet approved the first round of sales Thursday. So far, shares of a couple publically traded companies and a state-owned shipbuilder and air-traffic controller will be sold.

Selling (just 3% of) shares in Italy’s oil giant alone should raise €2 billion. Whether or not these sales suffice for raising public investment, they’re likely a positive for Italy’s private sector, the economic growth engine. Some may also argue it’s a potential short-term negative for other shareholders of the publically traded companies.

But the bigger picture is Italy’s Parliament was able to pass meaningful measures despite six months of tough gridlock—suggesting Italian politicians are still willing to do what it takes to help the economy. It wasn’t so long ago headlines feared Silvio Berlusconi’s PdL party would void the coalition after his conviction on tax evasion charges. That all at least seems like hot air at this point: PdL has split in two, and the faction supporting PM Enrico Letta’s government is big enough to keep the coalition intact. The privatization deals echo this small rise in political stability.

Portugal remains mired in its own form of political gridlock, too. Its Parliament has been able to pass a number of austerity and other measures, trying to get the country back on its feet. But its Constitutional Court seems bent against it: On three separate occasions this year, it ruled against necessary austerity measures, like state employees’ pay cuts and public-sector downsizing. The European Commission (and likely the Portuguese government) stated concerns Portugal may have trouble returning to bond markets as planned in 2014 should the court continue striking down measures. It’s worth watching, but in the broader picture, it’s more likely to amount to yet another cause of the eurozone’s much-maligned “uneven” recovery. (Whatever that means.)

Political gridlock is a big headwind for the eurozone, not just in Portugal and Italy—nearly region-wide. Normally, gridlock is good for stocks! It lessens the chances extreme legislation will be passed—and in Germany, that’s certainly the case (another eurozone positive). But the peripheral eurozone is so mired in gridlock, even pro-market, middle-of-the-road, necessary legislation struggles. Ultimately, we still expect the area’s leaders to take incremental steps forward, but that’s likely a slow process. Until much of the area’s ongoing political uncertainty clears up, the eurozone likely doesn’t excel.

That doesn’t mean the economic environment can’t improve some, though—the eurozone is still a part of the global economy, which is expanding nicely. And leading economic indicators largely suggest the eurozone’s growth continues ahead. Seeing how dour investors really are on the Eurozone suggests there is ample fundamental surprise power to lift stocks higher.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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