For much of the year the benefits of a falling oil price, a ‘devalued’ currency and a full-blown quantitative easing programme fuelled investor hopes that strong profit growth for eurozone corporates would finally, after eight long years, come through.
Cyclical stocks such as banks and automotive groups, traditionally the barometers of economic recovery, outperformed the more defensive consumer staples and healthcare sectors up until May, fuelling hopes that earnings growth was finally established as being on an upward trajectory.
Then summer and, more specifically, China ripped apart investor optimism. Global equities fell by almost 8 per cent over the traditionally quieter holiday period, spooked by devaluation of the renminbi and leaving investors with just one question: Had they witnessed a healthy stockmarket correction or was renewed weakness in world equities the start of something more sinister? But while equities wobbled, somewhat surprisingly, the bond market and the dollar remained relatively sanguine.
So how justified is the market’s change in mood music? Frustratingly for investors in eurozone equities the China story has got in the way of a slew of encouraging economic data.
According to the forward-looking purchasing managers’ index (PMI) data, which measures eurozone activity across manufacturing, services and construction sectors, momentum is still running above its long run average, with composite PMI for August at a four-year high. German retail sentiment indicators have come in at their highest levels since June 2011, Spanish GDP is on track for the government’s target of 3.3 per cent this year and even France’s economy is starting to show signs of life.
Further positive evidence points to the fact that the ‘summer scare’ bore all the hallmarks of an indiscriminate selloff in equities. Second quarter earnings for the euro area were one of the best ‘beats’ (the measure by which actual company earnings exceed analysts’ forecasts) in five years. Cynics could argue that the China impact hasn’t been fully reflected in results but then direct sales exposure to China at just over 2 per cent is relatively small. Admittedly, potentially more worrying for investors is the impact on sales growth from the Asia Pacific region as a whole but the jury’s still out here.
For the moment, all is relatively calm on the political front. The threat of Spain’s extreme right party, Podemus, entering office looks less and less likely with Rajoy’s centrist party set to gain a second term in office when Spaniards go to the polls in December. While talk of Catalonian independence may cause minor ripples, elsewhere in the eurozone markets have generally become more immune to the result of yet more Greek elections in September.
Structural reforms in Spain, Italy and to a lesser extent France are making good progress. Labour reforms, pro-business reforms and a reduction in corporate tax rates should help support improving profitability. Profit growth is still on track for 10 per cent this year and next, consistent with 1.5 per cent growth for the eurozone as a whole.
Europe’s economy has survived the first – and clearly most painful – part of its recovery process. Now it is comfortably in its rehabilitation phase clear and sustainable signs of growth are emerging.
Kevin Lilley is manager of the Old Mutual European Equity Fund and Old Mutual European Equity (ex-UK) Fund.