A quick look at a timely topic of interest - with a brief review of why it could matter to investors.

Chart of the Week

August 18, 2014

Eurozone recovery: slip sliding away?
Eurozone GDP and consumer price inflation

chart

Source: Bloomberg, as of 8/14/14. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line:

  • Last week's GDP report showed the Eurozone no nearer to the sustainable expansion that its leaders have hoped for.
  • The 0% growth rate in Q2 ended four consecutive quarters of modest gains and set growth from a year ago back to just 0.7%.
  • In the region's three largest economies, GDP in Germany and Italy contracted 0.2%, while remaining unchanged in France.
  • Meanwhile, Eurozone consumer price inflation is sliding toward zero—intensifying concerns about deflation. The unemployment rate, holding steady at 11.5% offers little solace.
  • All this paints a pretty dim picture, one that could grow even dimmer if trade sanctions with Russia escalate and/or conflict in the Ukraine intensifies.
  • Current financial asset prices certainly reflect low expectations about the future. As of 8/14/14, German bund yields were at a record low 1.01% and the MSCI Europe equity index was down 5.6% from 6/30/14.
  • Yet, low expectations can be a positive for long-term investors—the forward price/earnings ratio of the MSCI Europe for 2015 is just 13x.
  • That could prove especially true in Europe if the lack of economic traction persuades the European Central Bank (ECB) to take more aggressive action by making outright purchases in the asset-backed securities market and leads to economic reforms at the country level.

The Chart:

  • The chart shows the year over year change in Eurozone GDP and consumer prices over the past five years.
  • On a year over year basis, Eurozone GDP turned positive in 4Q13, growing 0.5% following seven consecutive quarters of decline. It expanded by 0.9% in 1Q14, but slipped to 0.7% in 2Q14.
  • Eurozone consumer price inflation has been in a decline since November 2011 when it was 3%; the most recent annual rate was 0.4% for July 2014.

Context & Perspective:

  • Following its latest meeting on August 7, 2014, ECB President Mario Draghi gave perhaps the strongest indication yet that quantitative easing (QE), European-style, could begin soon—noting during the press conference that the ECB had "intensified preparatory work related to outright purchases in the asset-backed securities market."
  • With growth now stagnating, inflation just 0.4% (well below the ECB's target rate of 2%) and the potential for trade sanctions—like Russia's ban on European food imports—to drive growth and prices even lower, the ECB may be forced to move more quickly with additional monetary stimulus.

Definitions:

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

Bund is German for bond.

The MSCI Europe Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance in Europe: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

The price-to-earnings (P/E) ratio is a stock's (or index's) price divided by its earnings per share (or index earnings). The forward P/E ratio is a stock's (or index's) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.

The European Central Bank (ECB) is responsible for the monetary system of the European Union (EU) and the euro currency.

Quantitative easing (QE) refers to a monetary policy implemented by a central bank in which it increases the excess reserves of the banking system through the direct purchase of debt securities.


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Poll

Which Asian country will have the strongest growth in the coming year?

Japan, as Shinzo Abe's policy initiatives take hold
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Go for growth: Where will a global recovery be strongest this year?

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