Europe's Recent Data Divide

A curious trend appears to have emerged in Continental European economic data in recent weeks—one we think is worth watching. Whilst so-called soft data (e.g., survey-based indicators, chief amongst them purchasing managers’ indexes, or PMIs) have stayed strong across the board, some hard data (e.g., output measures like retail sales and industrial production) have struggled. As we will show shortly, French industrial production and German retail sales defied PMIs with contractions in recent days, missing analysts’ consensus expectations in the process. German industrial production, released Wednesday, did grow 0.7% m/m in April, but that figure also missed expectations—and follows a worse-than-expected -3.7% decline in March.^[i] Now, we don’t think this is predictive for eurozone stocks, as we think markets are forward-looking and these economic data reveal only what just happened. But we do think the data perhaps shed light on what eurozone stocks pre-emptively incorporated into share prices already, and, in our view, they illustrate the follies of relying too much on any one indicator.

Exhibits 1 – 4 show the past few months’ worth of hard and soft data for the eurozone’s four largest economies (Germany, France, Spain and Italy). We limited our look to this short window for a simple reason: Commentators we follow globally warn the war in Ukraine is a huge risk for Continental Europe’s economy, and that conflict started in late February.^[ii] We suspect one looking only at PMIs would presume all four have strongly sailed through this period. But harder data show some struggles.

Exhibit 1: Germany

Source: FactSet, as of 8/6/2022. All figures are seasonally adjusted and, where noted and applicable, adjusted for price changes (aka “real” or inflation-adjusted). Question marks denote data that aren’t yet released. PMI readings over 50 indicate expansion.

Exhibit 2: France

Source: FactSet, as of 8/6/2022. All figures are seasonally adjusted and, where noted and applicable, adjusted for price changes (aka “real” or inflation-adjusted). Question marks denote data that aren’t yet released. PMI readings over 50 indicate expansion.

Exhibit 3: Spain

Source: FactSet and Eurostat, as of 8/6/2022. All figures are seasonally adjusted and, where noted and applicable, adjusted for price changes (aka “real” or inflation-adjusted). Question marks denote data that aren’t yet released. PMI readings over 50 indicate expansion.

Exhibit 4: Italy

Source: FactSet and Eurostat, as of 8/6/2022. All figures are seasonally adjusted and, where noted and applicable, adjusted for price changes (aka “real” or inflation-adjusted). Question marks denote data that aren’t yet released. PMI readings over 50 indicate expansion.

Eurozone recession (a decline in broad economic output) warnings from financial commentators we follow have gotten louder as countries report more negative results, and we think these warnings very well could prove correct. Eurozone stocks, which fell as much as -22.0% from their prior high during this year’s downturn, have behaved much as we think they would if a regional recession were underway.^[iii] In our experience, stocks generally move ahead of economic turning points, and the eurozone’s decline began back in November.^[iv] We suspect one may argue Continental stocks spent this winter and spring pricing in a recession.^[v]

Whether or not that comes true remains to be seen, however. For one, hard data come out at a lag. We are just now getting April figures, and as the tables showed, some of those registered improvement. The earlier negativity all falls under Q1, and we already have Q1 gross domestic product (GDP, a government-produced measure of economic output) results.^[vi] Those showed Germany growing 0.9% annualised (the rate at which GDP would grow over a full year if the quarter-on-quarter growth rate repeated all four quarters) thanks to strong business investment, and France contracting -0.8%, with household consumption leading the way down.^[vii] Which brings us to the second caveat about all these monthly data: They are limited. Eagle-eyed readers will have seen French retail sales looking robust in Exhibit 2, which one might logically think points to strong household consumption. Yet retail sales exclude most services, and services happen to represent the majority of consumer spending.^[viii] So that is a big blind spot, in our view.

Similarly, official data show German factory orders declining month-over-month in February, March and April, with May’s figures to be released.^[ix] This might point to weak business investment, but that larger category also includes commercial real estate and intellectual property products (e.g., software and research and development).^[x] Then too, PMIs confirm some weakness in orders, as the manufacturing survey’s new orders subindex contracted in April and May, with many respondents noting slack demand from China—tied to now-ending lockdowns—as a driver.^[xi] And, whilst it doesn’t break the countries down, the German Federal Statistics Office noted April’s decline in factory orders was “mainly due to orders abroad.”^[xii]

In short, all monthly data have blind spots, in our view. We like PMIs because they are timely and have broad geographical reach within a country. But we also recognise their limitations: They reveal the percentage of businesses reporting increased activity overall, but they don’t report how much businesses overall grew (or shrank). Hard data, meanwhile, measure magnitude but only in specific categories that don’t always represent the whole.^[xiii]

Therefore, we think it is best to consider all available data, hard and soft, and determine what the totality says. In Europe’s case, we think it presents an overall muddy picture. There are probably pockets of strength in categories that benefit from the easing of COVID restrictions and the areas where supply shortages are reportedly less of a factor (e.g., manufacturing excluding autos). Defense-orientated manufacturing may also be contributing positively. It also may be that a majority of businesses are pulling through fine, but the minority that have hit tough times are contracting enough to offset the others and pull the total down. Either way, it points to a mixed bag, in our view—economies that aren’t firing on all cylinders but perhaps also aren’t in the dire straits so many commentators we follow presume.

For investors, we think times like this make it crucial to remember how markets work. Whatever economic data and scare stories observers dwell on, we don’t think they are sneaking up on stocks. If anything, we think eurozone stocks started pricing in a weakening economy well before economists started estimating the war’s impact. In our view, stocks look forward, discounting the next 3 – 30 months or so. There is no way to know exactly when eurozone markets will start discounting a coming economic recovery. They may already have begun to, given their low thus far was in March.^[xiv] Or—granted—the upturn since then could be a false positive en route to a retesting of the market low, but we think there is just no way to know this in advance.^[xv] In our experience, sentiment-fuelled swings are maddening like that.

At any rate, given the events eurozone stocks have already endured this year, we don’t think it is fruitful for investors to continue getting hung up on weak economic data if they keep rolling in. In our view, stock prices today likely already reflect whatever economic data show happened in April and May—they have lived through it and probably registered it in real time. Hard as it may be in the heat of the moment, we think looking forward and avoiding the temptation for spur-of-the-moment reactions is probably the most beneficial move for investors seeking long-term growth.