FPXE - When Will It Again Be Safe To Invest In Eurozone Stocks?
2023-11-16 23:20:00 ET
Summary
- Investors in Eurozone stocks have been taken for a roller-coaster ride thus far this year.
- These stocks performed strongly during the first several months of 2023 as the pace of economic activity and company profits beat market expectations.
- In March, market sentiment worsened as European economies appeared to be entering a stage of stagnation, with less-attractive company profit results.
By William H. Witherell, Ph.D.
Investors in Eurozone stocks have been taken for a roller-coaster ride thus far this year. These stocks performed strongly during the first several months of 2023 as the pace of economic activity and company profits beat market expectations.
In March, market sentiment worsened as European economies appeared to be entering a stage of stagnation, with less-attractive company profit results. A recession looked increasingly likely.
Eurozone stocks nevertheless recovered in the second quarter. Despite increasing headwinds, including tighter monetary restraint, these economies were proving to have greater than expected resilience.
This optimism did not last, however, as signs that the Eurozone economy was indeed stagnating became more evident in the third quarter. Eurozone stocks peaked in July, at which point the year-to-date gain for the iShares MSCI Eurozone ETF, EZU , was an impressive 22%.
This market then trended downward until late October, losing some 15%. Investors were selling Europe exposure. The only net buyers were European companies, for whom buybacks are a flexible way to return money to shareholders.
In the past several weeks, Eurozone stocks have again reversed, gaining some 11%. Is this recovery likely to be sustainable in the coming months?
The most recent economic data for the Eurozone imply that the recession is getting worse in the current quarter. The most negative signals come from the HCOB Eurozone Composite PMI survey data for October, which show the economy contracting at the fastest pace in nearly three years.
Indeed, for the fifth month in a row, the Composite Index, at 46.5, was below the 50 threshold that separates contraction from growth. Demand conditions were fragile, and employment conditions were stagnant.
Both services and manufacturing declined during the month. Business sentiment indicated a subdued level of confidence but was a little better than the September reading.
Among the largest Eurozone economies, Spain had the strongest Composite PMI at 50.0, followed by Ireland, Italy, and Germany. France was the lowest at 44.6, likely due to a fall in tourism.
The PMI report indicated that inflationary pressures felt by business respondents in the Eurozone remained surprisingly strong, in contrast to official figures reporting headline inflation’s easing to 2.9% for October.
Deflationary energy prices were a key factor, though they may not be sustained, as the energy situation is highly uncertain. European Central Bank ((ECB)) speakers are pushing back against hopes for early rate cuts in 2024, even though the economy is broadly weakening. Some of the lagged economic effects of the rate increases since July 2022 still have yet to be felt.
While monetary policy looks unlikely to ease in the near term, fiscal policy is heading in a different direction. In particular, the German government has announced a large package of subsidies for its industry.
For the Eurozone economy to begin a solid recovery in the opening months of 2024, the German economy, the largest in the Eurozone, would have to break out of its stagflation and start to grow.
The contraction of the German economy in Q3 was 0.1% from the previous quarter, which was milder than the expected 0.4% drop. Views that the German economy may be bottoming out in the current quarter received some support from the November German ZEW business survey, in which “expectations” rose to 9.8% compared to -1.1% in October.
Also positive were the low expectations for inflation and expectations for a decline in long-term interest rates. However, at -79.8, the reported current situation in November remained stuck in the cycle lows.
It is important to note that the German economy is in better shape than many had expected. It has shown greater resilience. Nevertheless, even if the mild recession in Germany is bottoming out, regaining momentum in the first half of 2024 will be difficult.
Foreign demand is likely to remain low. The continued effects of tight monetary policy will still be a headwind, particularly for construction.
Overall, with half the Eurozone economies contracting in Q3 and a further decline or, at best, stagnation likely in the current quarter, the Eurozone will begin the new year on a weak footing with risks clearly on the downside.
Momentum may well pick up as the year advances and headline inflation declines, possibly reaching 2% by midyear. However, the recovery is likely to be modest, with Eurozone GDP for year 2024 remaining below 1%.
In an expected global market environment that will offer limited opportunities, Eurozone stocks, with a relatively low P/E, 11.8% on the STOXX Europe 600, and relatively high earnings and margins, may be able to attract back some of the investment outflows experienced in 2023.
The one security mentioned above is not in the investments of Cumberland Advisors or of the author.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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When Will It Again Be Safe To Invest In Eurozone Stocks?