Despite Optimism, Europe is on Edge of Recession

With all the optimism that Europe is recovering from the debt crisis, all eyes are on released economic data. Today, we get the preliminary February Purchasing Managers Index (PMI) for the Europe.  As reported in Marketwatch: Weak PMI fans euro-zone recession fears.

The preliminary composite purchasing managers index fell to 49.7 in February from 50.4 last month, according to financial-information-services firm Markit, which compiles the index. A reading of less than 50 signals a contraction in activity.

Economists had forecast a rise to 50.8. The decline reflected a fall in the services PMI to 49.4 from 50.4 in January. The manufacturing PMI rose to 49.0 from 48.8 in January, a six-month high.

“A retreat back below the 50.0 no-change level for the euro-zone PMI is a disappointment, and highlights the ongoing risk that the region may be sliding back into recession,” said Chris Williamson, chief economist at Markit.

Euro-zone gross domestic product saw a quarterly contraction of 0.3% in the final three months of 2011 after growth of 0.1% in the third quarter. A recession is loosely defined as at least two consecutive quarters of shrinking GDP.

While analysts say that this report may or may not mean a recession will happen, I like to go to the source to see the details, which can be quite good.  Unfortunately due to the late hour and copyright laws, I am unable to include any information found in the source report because I do not have prior permission.  (I will work on this for the future.)

However, I encourage you to check out the report as it is only 3 pages and has commentary supported by numerous graphs.  If you simply want the highlights, skip to the Summary of February data on page 3.  The report can be found on Markit's website under Markit Commentary.  Here is a direct link to the PDF: Eurozone business activity slips back into contraction in February.

Looking at the trends in the graphs, the case can easily be made that the EU is on the edge of recession.  Personally with all the austerity, I do not foresee Europe avoiding a recession.  As noted in It's Just a Minor Flesh Wound, they're already halfway there.



Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

It's Just a Minor Flesh Wound

I've said it before, Europe is heading towards a recession.  Today we have confirmation that a number of EU economies are contracting:

From Marketwatch: Euro-zone GDP shrinks, cushioned by core

In a preliminary estimate, the European Union statistics agency Eurostat said gross domestic product contracted by 0.3% in the fourth quarter compared to the previous three months. Compared to the final quarter of 2010, GDP grew by 0.7%.

Economists surveyed by Dow Jones Newswires had forecast a 0.4% quarterly contraction. Euro-zone GDP grew by 0.1% in the third quarter.

Looking at individual countries:

Core economies cushioned the blow in 2012. National data showed France, the euro-zone’s second largest economy, defied expectations for a 0.1% fourth-quarter contraction to grow 0.2%.

Germany, Europe’s economic juggernaut, shrank by 0.2% versus forecasts for a 0.3% contraction, the federal statistics office, Destatis, reported Wednesday.

But Italy, the euro-zone’s third-largest economy and the country seen as the key battleground in the fight to contain the debt crisis, saw fourth-quarter GDP shrink by a larger-than-expected 0.7% after a 0.2% decline in the previous three months, the national statistics agency, Istat, reported Wednesday.

Slower growth makes it more difficult for countries to meet deficit-reduction targets which are measured as a percentage of gross domestic product.

On Tuesday, Greece reported that its economy shrank by a steeper-than-expected 7% on a year-on-year basis in the final quarter of 2011. Greece is entering its fifth year of recession, with unemployment topping 20% as political leaders continue to wrestle with demands from the country’s euro-zone partners to implement further austerity measures.

Spain saw quarterly GDP shrink by 0.3% after a flat performance in the third quarter. Portugal, which like Greece and Ireland was forced to seek a bailout from its euro-zone partners and the International Monetary Fund, on Tuesday reported a steep 1.3% contraction in fourth-quarter GDP.

The European Central Bank delivered two quarter-point interest-rate cuts in November and December, undoing hikes seen earlier in 2011 to bring its key lending rate back down to a record low 1%. The ECB also moved to further boost liquidity in the ailing euro-zone banking sector, providing a massive dose of three-year loans to commercial banks and taking other steps credited with easing funding problems inspired by worries over institutions’ exposure to sovereign debt.

...
In the core, the Netherlands saw GDP shrink by 0.7% after a 0.3% contraction in the third quarter. Austria also reported a decline in GDP, shrinking 0.1% after growing 0.2% in the third quarter.

One quarter only gets us half-way to the widely accepted definition of a recession of economic contraction over two quarters.  Yet unlike economists who expect growth to return, I'm not optimistic.  According to the CIA World Factbook, here are Germany's major export partners in 2009:

France 10.1%, US 6.7%, UK 6.6%, Netherlands 6.6%, Italy 6.3%, Austria 5.7%, Belgium 5.2%, China 4.7%, Switzerland 4.5% (2009)

France's major export partners in 2010:

Germany 16.4%, Italy 8.2%, Belgium 7.7%, Spain 7.6%, UK 6.8%, US 5.1%, Netherlands 4.2% (2010)

Italy's major export partners in 2010:

Germany 13.2%, France 11.7%, Spain 5.9%, US 5.8%, UK 5.4%, Switzerland 4.6% (2010)

Spain's major export partners in 2010:

France 18.7%, Germany 10.7%, Portugal 9.1%, Italy 9%, UK 6.3% (2010)

As each of these countries contract, their demand for goods from their trading partners will also contract.  As their major trading partners are each other, this does not bode well for future demand.  

As of the time I'm writing this, stock markets in Europe are higher by about 1%.  I leave it to the talking heads to guess why as no one truly can say there there is one particular reason why markets act the way they do.  

Ok, maybe I will stab a guess.  Remember that over the long run, stock market trade on future expectations, not what is happening today.  Hence, I guess that stock markets are see that today's data was better than economists expected and extrapolate that data out to the future.  However I wonder if the market is also growing complacent.

Here's what I will be looking for in future data to confirm market direction: export data from EU countries and how austerity measures are impacting local economies in the GDP revisions.

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Good News From Europe, Though I Have Trouble Seeing It

If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem. - J. Paul Getty

Yesterday in Maybe I'm Not a Lazy Investor, I wrote a select list of items I'm watching with a little detail.  Today I've found multiple headlines that provide a glimpse of more detail. 

Dip Me in Axle Greece and Call Me Slick - (adapted from Pixar's Cars)

I’m just going to say it, I’m sick and tired of Greece. The sheer number of emergency meetings, delays to meetings, proposed plans that need to be renegotiated, more delays... it’s time to amputate the leg off already as what originally was a cut has festered into something gangrenous.

Now if you’re thinking, aren’t we trying to avoid that as it might cause a financial meltdown? Greece cannot pay back what has already been lent to it. The first bailout was for €110 billion. The second bailout being discussed is now north of €130 billion. Moreover austerity measures are imposing a full depression on the Greek people. So how can Greece achieve the growth needed to pay off its debts? It cannot.  Additional lending to Greece is simply throwing away money that could go to recapitalizing EU banks. I shake my head when I think about what if the EU cut Greece loose at the beginning - what would be the difference in costs compared to the never ending bailout?

That brings us to todays news from Marketwatch: Greek bailout hopes rise amid ECB concession

Talks between Greece and international creditors over a second bailout stretched past yet another deadline, but appeared to be moving toward a conclusion Wednesday after the European Central Bank reportedly agreed to exchange Greek government bonds at less than face value in an effort to further reduce the nation’s debt load.

In Maybe I'm Not a Lazy Investor, I stated:

Greece - will default. Honestly I don't know how anyone can classify a 50-70% loss on bonds as anything but a default. However, Greece is a known problem. Default is probably already priced in the market and may even be welcomed. What I'm watching here is how any last minute deal might apply to other EU countries in trouble.

It didn't take long after the ECB concession was announced for other financially distressed EU countries to want a fair deal. Reuters reports Irish want debt concessions if ECB aids Greece:

Ireland would see any European Central Bank contribution to the restructuring of Greek debt as a precedent that would boost Dublin's efforts to ease the burden of its own sovereign debt, the country's finance minister said on Wednesday.

I expect Portugal's relief request to swiftly follow. When the day comes where Italy and Spain again need help because austerity measures without labor market reforms choke their growth, it's better than an even money bet that they too ask for fairness.  The sad fact is fairness comes at the expense of the taxpayer.

France's Upcoming Election Risk

In Maybe I'm Not a Lazy Investor, I stated:

France - an upcoming election projects President Sarkozy to lose, which will inject a new risk as the next President may not follow the same policies.

Marketwatch reports: Francois Hollande will spark next euro crisis

With a first round in April, and a second in early May, Hollande seems a near-certainty to be the next president. The latest polls show the Socialist candidate beating Sarkozy by 45% to 30% in the first round, with the rest of the votes going to the centrist Francois Bayrou and the far-right, anti-euro candidate Marine Le Pen. In the runoff, the polls show Hollande winning by 15 to 20 points.

Furthermore Marketwatch reports:

First, he has no experience of running anything. A career party official, he had dedicated his life to the arcane inner machinery of the French Socialist Party.
...
Worse, Hollande has pledged himself to renegotiating the new fiscal treaty that (German Chancellor Angela) Merkel has just imposed on the rest of Europe, demanding strict adherence to balanced budgets over the medium term — a decision that almost certainly means the treaty will not be passed. A strong Franco-German alliance has been the key to keeping the euro together so far, but these two will hate each other.
...
Thirdly, Hollande has pledged himself to an old-fashioned borrow-and-spend program. What’s on the agenda? An extra 60,000 teachers, at a cost of 20 billion euros. Another 150,000 state-aided jobs. Higher taxes on the rich, and a financial transactions tax on the banks (although surprisingly, banking is a relatively successful French industry). A reduction in the retirement age from 62 to 60, when every other developed country has decided that longer life expectancy means people need to work longer as well.

So let me summarize: the French elections strongly favor a candidate wanting to expand benefits and the government sector by raising taxes and borrowing to cover the cost.  Deja vu as this is the same model that got Greece into its present situation.  With public debt of ~85% of GDP, it may only take a Hollande victory plus an EU recession for bond investors to see the resemblance.

About that EU Recession

With the governments of Greece, Portugal, Ireland, Spain, and Italy all cutting back via austerity measures, where will European growth come from?  Don't count on Germany.  Not only is it undertaking some austerity measures to balance its budget, but it's primary trading partners are cutting back on their purchases.  As Bloomberg reports: German Exports Slump Faster than Forecast as Crisis Damps Growth

German exports fell four times more than economists forecast in December as the sovereign debt crisis damped growth across the euro region.

Exports slumped 4.3 percent from November, when they rose 2.6 percent, the Federal Statistics Office in Wiesbaden said today. Economists predicted a decline of 1 percent, according to the median of 17 estimates in a Bloomberg News survey. French business confidence held near its lowest level in more than two years in January on recession concerns, the Bank of France said in another report.

While I'd like to be optimistic, I cannot see where the growth will come from in Europe to avoid a recession.

So How Does this Affect Me Here in the US

As the European economy weakens, the euro will also weaken versus the dollar.  A stronger dollar hurts US exporters in two ways:

1. It makes their products more expensive in Europe, so people there are less likely to buy US products.
2. Profits from Europe will fall when converted back into dollars due to the foreign exchange rate.

In other words, US companies may sell less and will get fewer dollars per euro of profit.  As the Fiscal Times reports, Eurozone spending accounts for 41% of S&P 500 revenue, which strikes me as a significant number.  So selling less + smaller currency conversion =  a good possibility that cheaper stock prices are in our future.