While European exports have shown some signs of revival in the past few months, European manufacturing activity remains muted. Even in Spain or Ireland where growth had been encouraging year-to-date, October did not bode well. Germany and France, unlike the UK, are also under pressure.
The European recovery from the latest financial crisis has been very slow due to a combination of structural and macroeconomic issues. Should investors continue to wait for a meaningful revival in growth in Europe? Or would their hope be in vain, like that of the characters in Becket’s play “Waiting for Godot"? While a new wave of Quantitative Easing could help Europe in the short-term, the global environment could become less supportive.
A balancing act for Europe: slow improvements in a deteriorating global environment There are some positive factors supporting European growth going forward and they should not be ignored. Those include the weak Euro, the scope for supporting fiscal policy in 2016 and low commodities and oil prices. With over 55% of EU GDP driven by private consumption, the positive impact of low oil prices can be significant, especially in the second and third years after a meaningful fall in energy prices. The European credit cycle has also been sluggish but its rate of change in October is showing some signs of bottoming out, which could bode well for a revival. With banks still representing 80% of lending in Europe, positive bank lending in October for the first time in over 35 months could be a turning point.
Confidence indicators for European households have improved but unfortunately this is not yet the case for corporations. The corporate sector is in fact showing low conviction in any meaningful European recovery. The Capex-to-sales ratio is at a 30 year low, unemployment levels are sticky and European profit share-to-GDP is down, unlike in the US.
In addition, while in general the impact of the China slowdown on European earnings overall is quite low, it is sizeable for Germany and the impact of a strong emerging markets economic slowdown would be important for European earnings. The Chinese economic slowdown is structural and will continue to unfold until the economy finds its new equilibrium. The October trade numbers in China point to a continued slowdown of the global and domestic economy as both imports and exports were weak.
In Germany, recent numbers show that industrial production fell 0.3% in the third quarter 2015 from the previous period as manufacturing output dropped. The US has so far counterbalanced the slowdown in European exports to emerging markets. However with US third quarter GDP slowing to 1.5% quarter-on-quarter annualized from 3.9% in the second quarter - despite a healthy private consumption - it is fair to question whether the US support to Europe will continue in the same vein going forward.
Rising global and European divergence Rising divergence themes between various world economies have been discussed widely and by many. With US earnings significantly above their prior peak and European earnings still approximately 20% below their previous peak the “earnings divergence” is clear on a global basis as well as within Europe.
With global growth slowing and a sluggish domestic environment, Europe is back to“speaking QE language”. From a US perspective, a step in the direction of rate normalization would be a relief for many. We should expect a rate rise as soon as the US gets a sense that the fragile global context gives it such an opportunity. The implementation (as opposed to its anticipation) of such divergent monetary policies between the US and Europe may well provide the markets with a sense of angst (is a rate rise in the US a policy mistake?) and short-term euphoria (more QE in Europe) that should be carefully assessed to anticipate the direction of markets and relative currency moves over the next 12 months.
Another source of underestimated divergence within Europe is on the political front. It is specifically linked to the “appropriate” response to the ongoing refugee crisis. Immigration is not a new phenomenon and in fact has accelerated in recent decades, up 50% to 232 million between 1990 and 2013 versus a world population growth of 35% during the same period. During that time, international migration has increased “in size, scope, complexity and demographic significance”*. But it is the intensity of the dual variables of size and time of the most recent immigration trend in Europe that is unusual. In fact it has lead to significant divergence of political responses between European countries, from border closure to “open arms”. The crisis has also had a divergent impact on individual European countries including geopolitical winners such as Turkey - and further political polarisation (Poland, Austria, France, Hungary, Denmark). Not much has been said, however, about the potential positive economic impact of the refugee crisis. Many economic studies show in fact that over time immigration is a contributor, not a detractor, to economic growth.
In fact if one takes a demographic perspective, it is interesting to understand how the current ongoing immigration could benefit Europe over the medium-term. Germany is a textbook example as its demographic profile is one of the worst in Europe. Its 2014 population of 80.1 million ** will drop to an estimated range of 67.6 to 73.1 million*** by 2060 and its over-60-years-old population will rise to 39% from 27%. The total cost of the elderly in Germany in 2013 was 19% of GDP and will increase to nearly 24% of GDP in 2060, with its dependency ratio - the ratio of pensioners to workers - expected to increase dramatically as it could be as high as 63% or 67%***. Another way to look at it is to expect an important drop in Germany’s working population after 2020 to roughly 34 to 38 million in 2060***. Migration is one of the tools that Germany can use to help mitigate this negative demographic trend. Absorbing large immigrant populations will of course take much political skill and innovation in a context of lower growth for longer, but if done successfully could be a defining factor for Europe in general and Germany in particular.
Conclusion While the divergences mentioned above are not necessarily negative, they are factors that need to be carefully taken into account as investors assess European prospects in this new upcoming phase of global economic transition. Those themes might flare up in ways that would add to uncertainty to a delicate global equilibrium. Clearly one of the major risk for Europe at this point is that it “runs out of time” to unfold a meaningful fundamental recovery in the context of a slowing global economy, a potential rate increase by the Fed, the continued structural shift in China and the on going maturing of emerging markets growth. While additional European QE could help the markets in the short-term even if the underlying European macro economic picture is not strong the key to understand how long such a rally might last lies in what happens in the rest of the world.
SOURCES * UN: Concise report on the world population in 2014 ** World Bank *** Statistisches Bundesamt
ABOUT THE AUTHOR
Virginie Maisonneuve Managing Director
Virginie is founder and Managing Director of Maisonneuve Global Advisors. Virginie’s background in asset management spans over 28 years and she served most recently as CIO-Equities, MD at PIMCO (London). Prior to this she worked as Head of global equities at Schroders (London), Co-CIO at Clay Finlay (New York) and held various senior portfolio management positions at State Street Research (San Francisco), Batterymarch (Boston) and Martin Currie (Scotland). She started her career as a consultant for the French Ministry of Foreign Affairs in Beijing (China).
Virginie has an MBA from ESLSCA (France) and a BA from Dauphine University (Mandarin Chinese). She also has a first degree diploma in Political Economy from People's University (Beijing, China) and is a CFA Charterholder.
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