Is the European economy really back on track?

Since the start of the New Year, our esteemed European leaders continue to insist to their populaces that the worst of the crisis is behind us and that all the austerity measures imposed upon the Southern European countries in particular were both absolutely necessary and are now having positive effects. Mmmm…

The latest economic datasets out of the UK, Spain, Italy, France and Greece with, continued social unrest in the latter’s cases and the election results from Italy last week do not, to us, seem to be following the politicians script. European PMI data presented on Friday revealed the nineteenth consecutive contraction in the Eurozone. The IMF’s projections show that as a bloc, the Euro region will, only in 2017, just about recover to where it was in 2007. Looking at individual countries within Europe shows a wide disparity between them with of course, the Southern European nations experiencing the worst of the economic decimations. With all this in mind, you can be forgiven for asking the question – is it really time to go all in in the markets?

Equity markets have certainly been on the rise since the beginning of the year with Japan, as speculated here, continuing to be in the vanguard. The Dow is up 7.3% this year and the Nikkei has added a further  11.7% to last year’s 22.9% rise – that is a bull market by anyone’s stretch. The FTSE is, surprisingly, second from top of the list. What the UK and Japan both have in common is depreciating currencies, and this is the problem for overseas investors – what they are gaining in local terms they are losing in currency adjustments…

The table below however shows that it is Europe where the enthusiasm is vanishing with Italy the notable underperformer – being down on the year now whilst the German Dax & French CAC have put in lackustre performances. Several events have dented optimism in Europe in recent weeks and we think the scenario being played out here will only worsen if there isn’t a change in the politicians thinking away from austerity at all costs.

Analysts have been expecting 2013 to be the year of that much anticipated recovery in European GDP growth and a halting of the never ending rise in unemployment – particularly amongst Europe’s youth but, sadly, the latest economic predictions have been cut and cut again. Even in the US which was showing promising signs at the end of 2012, GDP has been flat in the latest reported quarter – although we suspect a lot of this was “fiscal cliff” fear induced. Commodity stocks which also sparkled at the year-end are firmly now back in the doldrums and so pointing to a slowing in the overall International picture. Gold, silver, copper etc are all falling in price.

PMI data presented last week by Markit produced a reading of 47.9 for the Eurozone as a whole with 50.3 for Germany and 43.9 for France. The reading shows contraction for the nineteenth consecutive month as we detailed above – this is a damning verdict on European policymakers and one that is having real social costs for her people. One could argue that the rate of contraction is decreasing as pointed to by the Markit data, but that is really just a way of saying that we are becoming increasingly poor albeit at a slower rate!

Austerity has failed and any good Economics Professor could have predicted this before it was applied in the fact of credit contraction and slowing external markets. It is obvious.

With quite simply too many countries applying too much austerity at the same time – who is left amongst the globe to consume – Latin America? Africa? Australia? The global economy needs Europe to reverse its current austerity course and look to generate bloc wide growth. Debt is still high, unemployment at appalling levels and grinding higher too, GDP growth fleeting and poverty and social unrest are increasing. Some would say that at least Portugal has been able to return to the debt markets and hat France and Spain are paying lower yields on their debt but this is not having any effect on the man on the street. In fact, once could argue that the falling sovereign debt yields is only as a consequence of the ECB’s OMT program. Yields started decreasing once Super Mario stated that he “will do whatever it takes” to save the Euro. If the ECB had announced such a measure 2 years earlier, Europe could arguably have avoided much o the cuts that were made at the wrong time she would probably be looking much better now…

The world’s economy remains on life support. The machine behind it is called central banks and the technique being used is called massive liquidity injections aka QU. If this stops, we’ll probably have to say goodbye to the patient.

With the ECB supporting sovereigns with OMT and continuing to recapitalize the banks at a rate of 1% through LTROs, can you guess what has happened? The gains from the decreasing yields have been absorbed almost exclusively by the banks which have  massively bought government debt at higher yields. It is somewhat ironic to note that what led to all this mess was excessive leveraging by banks and yet the current measures being applied are effectively allowing them to play the same game but with the implicit approval of the Central banks this time…

Is it time to buy Europe? No, we think not now. Should Italy and Spain fall another 5-10% then we would be buyers again, but we believe last week’s Italian election may be the start of a troubled period ahead. Continue taking money off the table is our stance.