The euro area’s forward-looking economic indicators continued to brighten up in August. While Germany and France remain the region’s growth engines, we now also have signs of the South stabilizing...
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Mikio Kumada, Global Strategist at LGT Capital Management
The latter would be of great significance for Europe. Given that financial markets have been consistently signaling a constructive eurozone outlook for some time now, the economies of the “old continent” could indeed surprise on the upside in coming quarters.
Economic recovery in Europe reconfirmed
Last week’s euro zone purchasing managers’ surveys again confirmed the region’s economic recovery. The manufacturing activity index had already climbed above 50 points in July for the first time in more than two years. The services index duly followed in August, and the manufacturing index continued to rise, signaling continued euro area growth in coming quarters. So far, it is true that only Germany shows strong growth in both manufacturing as well as services, but Southern Europe is much less of a drag compared to three months or one year ago. In some cases, it has even started to contribute positively. Also, the growth differential between the North and South is now smaller than in earlier stages of the “euro crisis”.
Signs of life in Southern Europe: Portugal surprises with strong growth
After many years in deep recession, there is some evidence of an economic stabilization finally taking root in the South. The summer tourist season in the European Mediterranean region was very good this year, and tourism can be a critical factor for some of the Southern countries. Furthermore, Greece’s industrial production grew somewhat in June, instead of slumping further as had been predicted. In Portugal, the economy rebounded by much more than expected in the second quarter, surging to an annual rate of 4.5% as exports accelerated. Among major markets, only China is currently growing at a higher pace. However, in China, new bank loans worth 20% of gross domestic product are pumped into the economy each year, while Portugal is pursuing harsh austerity and faces a continued decline in total credit. Portugal’s current performance is therefore much more reliant on productivity gains – i.e. it potentially creates a stronger foundation for sustainable growth.
The financial markets have already voted for Southern Europe
Financial markets have been signaling a more constructive outlook for Southern Europe for more than a year now. The relative performance of the Greek stock market index, for example, began to stabilize after slumping to its lowest point in June 2012. Today, the Athens Stock Exchange index is up 43% compared to one year ago – the second-best performance after Japan. Peripheral European stock markets have been outperforming globally, with equities in Spain, Portugal and Ireland up by more than 20% over the past 12 months. Italy’s gain of only 13% looks comparatively low – but is still much higher than what most Asian growth markets delivered over the same period. The eurozone periphery’s government bonds have also been the world’s outperformers since mid-2012, despite very low credit ratings.
Party of “euro-area bulls” should continue to enjoy a growing followership
Important trends reversals are probably in progress whenever markets trade in such consistent ways over prolonged periods – even (perhaps especially) when the underlying economic case remains unconvincing from a factual or intellectual perspective. Markets can often discount or markup the future with a considerable lead time. It can take years before a trend can be sufficiently supported by fundamental arguments and is accepted by the consensus. Investing in an early stage of a trend is associated with higher risks and asset price volatility, but investors who prefer to wait until a trend is sufficiently established must also accept forgoing a potentially significant part of the expected excess return. At present, market participants are still split into “bulls” and “bears”, and the two parties are still in strong disagreement about the medium and longer-term prospects of the eurozone and the peripheral countries. This situation induces high volatility into markets from time to time. However, the euro area’s latest economic indicators should again help the bull party win more supporters – with the pool of “non-converts” still being very large.
Source: ETFWorld – LGT Capital Management
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