Economic data confirm that the Eurozone has exited recession.
There are signs that corporate transactional activity is increasing as businesses become more financially secure.
While Europe remains beset by challenges, the economic background is improving, valuations are looking more attractive and investors who have not been paying attention to European stocks may want to take a closer look.
According to Eurostat, the 17 eurozone member states showed seasonally-adjusted growth of 0.3% quarter on quarter in Q2 2013, confirming that the bloc has exited recession. Significantly, Europe’s largest economy Germany saw growth of 0.7%, but France also performed well, registering a surprisingly strong figure of 0.5%. In Portugal, the economy grew for the first time in two and a half years – by as much as 1.1%. Meanwhile, Spain and Portugal reported a drop in unemployment for the first time in two years.
Business confidence is also recovering. In Germany, the IFO business climate index climbed to 107.7 in September, the highest reading so far this year. Purchasing managers’ indices (PMIs) have also shown a recovery; for example, France’s composite flash PMI moved above the crucial 50 level in September, a 19-month high. The German composite PMI hit an eight-month high.
This should point to an uptick in earnings which have suffered a long period of negative revisions. Moreover, the pace of change is particularly interesting versus the U.S. market. European earnings are down by around 4% year on year (compared to the 2% decline seen in the U.S.) but it is clear from the chart below that we have reached a turning point.
Exhibit 1: Europe vs. U.S. earnings growth, 12 month trailing EPS growth, % year on year
Source: Absolute Strategy Research Limited/Thomson Reuters Datastream Section
There has also been some better news on the consumer side. Consumer spending in the eurozone stabilized in the first quarter of 2013 and there are signs that this has continued more recently:
- In September 2013, the flash consumer confidence indicator improved in both the euro area (to -14.9 after -15.6 in August 2013) and in the EU (to -11.7 after -12.8 in August 2013). The EU indicator exceeded its long-term average of -12.3 for the first time since June 2011 (source: European Commission).
- Crucially, labor markets have shown signs of stability and improvement, even in peripheral countries such as Portugal. In August, the 3-month moving average for euro-area unemployment reached a 28-month low.
How are corporates faring?
Businesses have been notably reluctant to spend through the uncertain times of the European crisis and capital expenditure (as a share of GDP) is at its lowest level for more than 20 years. On top of this, merger & acquisition (M&A) activity (see Exhibit 2) is at a low level. However, there are now signs that transactional activity is increasing as businesses become more financially secure. The benefits of industry consolidation and cheap funding (for good risks) means that many deals undertaken now will have lasting benefits for shareholders in terms of operating efficiency, pricing power, and sales and profits growth. With borrowing costs attractive, any increase in animal spirits should drive up capex and M&A activity, further supporting economic activity.
Exhibit 2: Western European M&A activity
Valuations remain attractive
Whilst we are some way off the rock bottom valuations of 2009, European equities have lagged the U.S. and UK and also look cheap compared to history.
Only a few months ago the eurozone was in meltdown. Bond spreads were widening, the political environment appeared fragile and earnings estimates were falling. Certainly, if you wanted to create an economic zone representing 17% of global GDP, you would not start from here. Nevertheless, we believe there are signs that the outlook is finally brightening. While Europe remains beset by challenges, the economic background is improving, valuations are looking more attractive and investors who have not been paying attention to European stocks may want to take a closer look.