This month’s economic data out of Europe confirm, if there still were any doubts, that a broad-based recovery is underway there. Global investment flows reflect this development, and it is not too late to participate. European domestic demand increased in the second quarter. It is likely that the widespread acceleration of consumer demand is working through the inventory cycle and stimulating business equipment spending and eventually employment.
The final European manufacturing PMI (Purchasing Managers' Index) reports for August were impressive. Next Monday’s euro-area composite PMI for September looks likely to show an increase for the sixth month in a row, according to a Bloomberg survey. The PMIs are based on surveys involving the polling of purchasing managers in the manufacturing sector and are widely regarded as important leading indicators of economic activity.
The August PMI for the Eurozone stood at 51.4, the highest level in over two years. Notable within that measure, the new-orders component rose to a level last seen in 2011. The largest Eurozone economies are leading the recovery inside the Zone, with Germany, Spain, and Italy registering increases while the PMI for France was stable. The emerging-market Eurozone economies are sharing in this recovery, with Poland’s PMI reaching 52.6, the strongest since early 2011.
Outside the Eurozone, the UK PMI rose in August for the sixth consecutive month. It reached 57.2, a level last reached in February 2011. Both new orders and output in the UK are now at levels last seen in 1994. Sweden’s PMI increased by 0.9 percentage points, registering 52.2, but this follows a decline in July that was twice as large. Switzerland’s manufacturing sector did not share the improving trend, declining from 57.4 in July to 54.6 in August. However, the Swiss PMI was still higher than in any other month (except July 2013) since May 2011.
The improving economic momentum in Europe has been confirmed by other surveys of business expectations and recent OECD composite leading indicators. The latter, in OECD’s September 9th release for both the Eurozone and the wider OECD Europe region, are clearly pointing towards growth’s gaining momentum. The recovery looks likely to be prolonged, with growth rates remaining modest. Within the Eurozone, only Germany and Ireland are likely to achieve GDP growth of 2% in 2014. Outside the Zone, GDP growth in the UK and Sweden next year is expected to exceed 2%, and Norway may well achieve 3% growth.
Foremost among the factors behind Europe’s recovery is the easing of tight fiscal policies, as governments focus more on promoting economic growth. Financing conditions have also improved, thanks to the European Central Bank’s easier policies and commitment to do whatever is needed to support the euro and provide liquidity to the Eurozone’s financial system. Similarly, in the UK, the Bank of England has stressed its new commitment to maintain its stimulative asset purchase program at least until the unemployment rate declines to 7%. Continued high unemployment rates do remain a headwind. The unemployment rate for the Eurozone remained unchanged at 12.1% in July, improving slightly to 5.3% in Germany, while France still suffers with an 11% rate, Italy with 12%, and Spain a daunting 26.3% rate.
The recovery is leading investors to move funds into European equity markets in a significant way. This has happened despite disappointing earnings in the second quarter, with deteriorating earnings revisions. Investors appear to be looking forward to stronger earnings due to the evident improved economic momentum. This optimism is evident in the rise of the consensus estimate for earnings per share growth for the STOXX Euro 500 from 1.3% this year to 13.1% for 2014. Profit margins, which had been falling, seem to be bottoming. Eurozone stocks continue to look cheap compared to US stocks. The price-to-estimated-book-value ratio of 1.6 in the Eurozone compares favorably with 2.25 in the US. It is still too early to worry that European markets are overbought. This recovery has legs.
Europe’s equity markets have led the world during the past three months through September 19th. Comparing MSCI equity market indices, Europe equity markets as a group advanced 14.9%, and the Eurozone markets rose 17.55%. In contrast, developed markets in Asia advanced at a much slower pace, with Japan up just 6.5%, while the US market rose 7.6%. Emerging markets did reverse their recent weakness and are up 8.7%. European ETFs rank highly by essentially all measures of momentum.
Subsequent Commentaries will include "Investing in the Recovery in Europe, Part 2"; "Eurozone Equity Markets After the German Election"; and "European Equity Markets Outside the Eurozone."
Source: Cumberland Advisors
