This year has seen European equity markets rally hard, despite what seems to be a deteriorating geopolitical environment with Greece having only bought 4 months of time and the Russian/Ukraine situation continuing to worsen.
But what is interesting is that there are signs emerging that European growth is going to recover in 2015, which is what the market has moved to price quickly. Here are 3 anecdotes why:
- Spanish Retail Sales are growing at 6.5% a year. Whilst there is still a lot of issues in Spain, namely mass unemployment, at the margin consumers have decided that can wait no longer. Whether this 6% is sustainable or not, the days of “bad” deflation (falling end demand) seem to be behind us (white box)
- German Unemployment is about to be lower than Australian Unemployment for the first time in 21 years. Whilst Germany is acknowledged as the “strong man of Europe” the strength of the level of job creation has remained elevated, leading to good GDP growth.
- European data is as almost as good as US data on forward looking Industrial survey data:Using surveys which are called “Purchasing Manager Indices” these are surveys of management inside large firms, is seen by markets as a good lead on future developments in the economy. On this front, whilst the US remains good, the changes to better are all in Europe with Europe now going back towards the highs of 2013. Based on the retail sales data, one would expect this to go higher.
So what is causing this? 3 Drivers:
- Oil Price The oil price has fallen in USD terms by 50-55% since July 2014. For countries such as Australia, not using US Dollars, have still seen a 35% fall in petrol pump prices. Europe is about the same quantum. Some estimates put the effect at 0.4% to 0.6% of GDP if it stays below $60. Spain for example does well also out of its external balances as it’s a large oil importer (other countries produce more locally, like the UK, so it’s more an internal wealth transfer).
- Interest Rates globally we are seeing interest rates moving to all-time lows out of both deflation fears and Central Bank pump priming. We think that their fears of deflation are focused on the wrong thing – the lower price levels. Now, the net effects of the cuts are hard to quantify, but to quote the old Friedman saw “monetary policy works with long and variable lags”. These moves should start to show up in the data some time through 2015, adding more fuel to the data we have already seen.\
- Currency: The ECB has successfully driven the currency down by 13% over the last year on a Trade Weighted Basis and by almost 20% versus the US Dollar. The Eurozone as a whole runs a Trade surplus, meaning they are net exporters, so this will add to GDP through 2015 (along with Earnings for listed companies.
European stock markets have moved swiftly to price this news and the announcement of Quantitative Easing by the ECB in January. The DAX, the German stock market, for example is up 15% already in 2015. Investor sentiment, as measured by the Bank of America Merrill Lynch Fund Manager Survey (Chart 2 below), shows large inflows into Europe in the last month.
As such we would say that there is a risk in the short term that these markets have gotten a little ahead of themselves in their exuberance (after all earnings – the blue line below – are yet to start moving up, so we have seen a large expansion in multiples (brown line) and would expect to see some consolidation or pullbacks. We would look to accumulate a position on these pullbacks.