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The economic data in North America is mirroring the earnings activity as growth expectations are getting ratcheted down due to falling exports and reduced capital spending, particularly from the energy sector. While the employment and domestic consumer data continues to be relatively strong, the sharp rise in the value of the U.S. dollar has become a drag on growth.
But in Europe the opposite has been occurring as they benefit from the depreciation of their currency with export-based companies starting to flourish. The Purchasing Managers Index for both manufacturing and services is currently signaling economic expansion in the Eurozone after lagging most global economies during this entire recovery. With the European Central Bank beginning a program of monetary easing, growth should pick up even further. At the beginning of the year it looked like problems in Greece and Russia would push Europe into a recession and the continent would experience deflation as well. Now, three months later, the outlook has improved. The combination of lower oil prices and a decline in the Euro has helped the consumer and increased exports. In Germany, the most important European economy, the Industrial Production Index now is in growth territory. Consensus estimates of real GDP increases for the continent are now in excess of 1%. Unemployment is down to 11.2% and German retail sales in January were up 2.9% month to month. Consumer confidence is rising almost everywhere. Even Spain and France are looking better.
The chart below shows the Citigroup Economic Surprise Indices for the Eurozone, Japan and the U.S. The U.S. started heading lower in 4th quarter of 2014 as growth slowed down and started to miss expectations. The Japanese data had been a little better than expectations, but it is important to note that these expectations are still very low, with most analysts still seeing that economy locked in a deflationary spiral. In fact the most recent Tankan Survey in Japan came in well below expectations, suggesting that ‘Abenomics’ is not really working and that economy is not showing any recovery. The European data has been improving however and coming in well ahead of expectations. This should be no surprise as the value of the Euro has dropped by over 20% in the past 4 months as the ECB cut interest rates and started their own aggressive QE program, not unlike the one that just concluded last October in the U.S. Europe is also a major net importer of oil so the precipitous fall in oil prices over the past 6 months is a clear benefit to them.
However, to sustain this better growth we have to see some economic reforms take place in the Eurozone in order for companies to improve their profitability and consumers to feel more confident about spending. Also, the Greek financial bailout continues to be a key risk. While the newly elected government races to deliver a promised list of reforms to its European creditors, Prime Minister Alexis Tsipras has been trying to prepare the Greek public for the likelihood he won’t deliver fully on his promises. The simple reality, in our view, is that Greece will never be able to repay its debt in its current form. So either the lenders have to give some major concessions on the debt repayments (effectively writing off a good portion of the debt) or the Greeks would have to default on the debt and then most likely also leave the European Economic Union. This Greek exit from the EU, or the so-called ‘Grexit,’ is not priced into financial market at all right now and represents just one more risk to global financial markets.