- Recent reports suggest eurozone manufacturing output might be showing signs of life
- Structural problems persist
- Investors consider that an economic recession may be inevitable, according to Sentix index
- Employment figures offer some pointers to the next move for GDP
- Green shoots or a false dawn?
Eurozone industrial production has been in decline since peaking one and a half years ago. The troughs and peaks of the index can be exacerbated by the seasonal and one-off factors that are involved, but the downward trend has been noticeable and worrying for investors. Bloomberg reported on 8thJuly that the Sentix index survey of investors posted its lowest reading in almost 10 years (Source: Bloomberg). The survey finds that an economic recession is now thought to be ‘inevitable’. Some sectors have at times gone against the trend and other indicators have suggested renewed life. These have not yet been able to turn the tide of weakening global demand for eurozone manufactured products.
Given the high point for production was December 2017, the length of the downward movement is obviously a concern. The five year chart also illustrates how, up to that date, the index formed a noticeable upward trend. The data for May 2019 showed a month-on-month change of +0.86%. This needs to be put into context as being -0.47% compared to the same time one year ago. But is it a blip or a turning point? The one indicator that continues to give contrarians hope is that employment levels have remained high despite the slump in actual output. Taking comfort from the fact that employees are also consumers could be the factor that reduces the risk of an out and out recession.
The global geo-political situation remains anything but certain. The eurozone has engaged in its own trade wars with the US but the US-China stand-off is probably more of a concern. Optimism persists that European products may be in demand, as substitutes for goods from those countries are priced out of the respective markets through the use of punitive tariffs. This may well be proved to be correct. One reason to think this may be more than wishful thinking is that German exports to both the US and China have held up. To date, the amount of exports from the eurozone has been rising – though business surveys show this may be about to change.
The problem for European manufacturers is that the rate of increase in growth is declining and some of the Q1 2019 demand looks to have been related to the UK stockpiling in anticipation of Brexit. Data is also coming into the market suggesting that eurozone companies are falling away in terms of international competitiveness.
The question is whether the pick-up in the production in May is a blip or a turning point.
Germany, the work-horse of the eurozone economies, has flirted with recession since the second half of 2018.
Data over the last 12 months has been reviewed and frequently downgraded, but despite flat-lining, the economy has just managed to avoid posting negative growth for two consecutive quarters.
On 5th July, The Telegraph reported the Bundesbank was not too hopeful of what the future might hold:
“Last month the Bundesbank, Germany’s central bank, slashed its 2019 forecast for the country’s struggling economy. It expects GDP to grow by just 0.6pc this year, a sharp downgrade from the 1.6pc expansion predicted in December.”
Source: The Telegraph
The ability to avoid entering a technical recession is quite remarkable. Taking reports back to the 1970s highlights that any decline in industrial production that is this long and this deep has typically led to a contraction in GDP.
Signs of life
Friday 12th July saw US equity markets post record highs. The S&P 500 Index printed at the 3,000 level for the first time and the Dow Jones Industrial Average index closed at 27,332. Equity markets in Europe have been buoyed by the European Central Bank’s (ECB) relaxed monetary policy but have not been marking record highs. The DAX index closed on Friday at 12,232.
With the appointment of Christine Lagarde as the new head of the ECB, we might be entering a time where the ECB and Fed vie for the title of the ‘most dovish’ central bank. Speaking last Wednesday, Jerome Powell, Chair of the US Federal Reserve certainly gave shareholders just the kind of news they like to hear. Last week’s news ‘love-in’ even extended to the much maligned banking stock Deutsche Bank AG. The German bank has been disappointing shareholders for many years but received its first broker upgrade since the announcement that it would be undertaking a massive, and very costly restructuring program.
The German service sector has also shown strength and is the part of the economy that is responsible for keeping the recession at bay.
The industry website for the consultancy sector, Consultancy.eu, this morning reported more good news:
“The management consulting sector of Germany has grown by more than 7% for the fifth consecutive year, despite the nation’s economic troubles of late.”
A key driver for the service sector is that German consumers have typically remained in employment – somewhat surprising given the slump in manufacturing. The below chart illustrates how employment in the manufacturing sector continues to grow despite the drop in actual output. Another interesting feature found in the detail of the data points to some rotation taking place in the workforce; there are more lay-offs but short-term hiring is at the same time picking up.
The consequences for the rest of the eurozone are potentially massive. Florian Hense, a eurozone economist at Berenberg bank picked out the areas most at risk from a German downturn.
“The more an industry-led German recession would spread to the domestic side of the economy, France, Spain and tourism spots in the south (of Europe) would suffer too,”
Whilst an apparent disconnect between manufacturing output and employment levels persists, household expenditure can be expected to continue to keep GDP growth (just) above zero. Quite how this employment/output conundrum resolves itself will offer a strong clue as to the next move in the markets.