The Well-Known Lesson From Q4 Eurozone GDPs

Q4 gross domestic product (GDP, a government-produced measure of economic output) for several eurozone nations have come out over the past week. Amongst the financial commentators we follow, some noted the bloc’s return to pre-pandemic levels of output, but most focused on the slowdown due to Omicron. IHS Markit’s January’s purchasing managers’ indexes (PMIs, which are widely followed monthly business surveys) added more evidence of COVID measures’ impact, with some analysts (correctly, in our view) noting growth will likely pick up as restrictions ease.^[i] To us, the broad discussion of restrictions’ economic impact shows how familiar society is with the script today. We think surprises move markets most, and at this point, restrictions lack shock power.

Eurozone GDP grew 0.3% q/q in Q4, missing expectations of 0.4% but enough to bring output above pre-pandemic levels.^[ii] (Exhibit 1) The bloc’s second-biggest economy, France, grew 0.7% q/q, whilst Spain (2.0%) and Italy (0.6%) also reported growth.^[iii] However, Germany, which many observers we follow view as Europe’s economic engine, contracted -0.7% q/q.^[iv]

Exhibit 1: The Big Four Eurozone Economies’ Post-Pandemic GDP Climb

Source: FactSet, as of 31/1/2022. Real GDP for eurozone, Germany, France, Spain and Italy, indexed to 100 on 31/12/2019.

That German dip grabbed the most attention amongst the financial publications we follow. Though the Federal Statistical Office hasn’t reported the underlying components yet, the agency’s press release blamed the contraction on Omicron-related restrictions.^[v] We read some experts argue the country’s economic struggles will continue in early 2022, and a few even forecast recession (a broad-based decline in economic activity).^[vi] Considering Germany is the largest eurozone economy, some argue as it goes, so goes the region.^[vii] But we don’t think near-term German economic weakness means contraction is coming for the broader eurozone, much less the global economy. For one, the country’s heavy industrial base makes it uniquely vulnerable to supply chain problems. Since both manufacturing and exports comprise a larger share of German GDP than in France, Italy or Spain—as well as the broader eurozone—bottlenecks and shortages weigh more heavily on German growth.^[viii]

Moreover, a local or regional spell of economic weakness won’t necessarily have broader global fallout. Japan endured recessions (using the popular definition of two consecutive quarterly GDP contractions) in late-2010 – early-2011, 2012 and 2019.^[ix] In 2012, we read headlines that bemoaned the UK’s double-dip recession (when GDP contracts for at least two consecutive quarters following a brief recovery from an earlier recession) after GDP shrank in Q1.^[x] However, we think all that fretting turned out to be misplaced after the ONS’s regular annual GDP revision in 2013 showed output was actually flat in Q1 2012—wiping away that downturn.^[xi] At any rate, even when many commentators we follow thought Britain had double dipped, UK stocks rose 6.0% that quarter—they acted unbothered by the phantom recession.^[xii]

Even when US GDP contracted in 2011 and 2014, that didn’t spell trouble for the global economy or markets.^[xiii] Now, 2011’s Q1 and Q3 contractions did coincide with one correction—a short, sharp, sentiment-driven decline of about -10% to -20%—during the summer and a pullback of -8.8% in the autumn.^[xiv] However, we think fears surrounding the US debt ceiling and associated credit rating downgrade chatter, along with the eurozone’s debt crisis, played a bigger part in knocking sentiment than US GDP’s small contractions. Furthermore, there was no global market correction in Q1 2014, when US GDP dipped more than either of 2011’s brief contractions.^[xv]

Now, we don’t think Q4 2021 GDP will indicate much about the eurozone’s 2022 economic prospects, but the widespread reaction can tell you about sentiment—and the handwringing over Germany’s contraction suggests scepticism remains prevalent. However, we have seen many analysts project growth to resume and even accelerate once restrictions ease—which has started happening. This week, France began lifting COVID measures, and Italy relaxed restrictions for travelers from EU countries. Denmark, though not a euro member, just became the first EU country to lift all COVID restrictions. Now, whether restrictions ease altogether or linger is impossible to assign probabilities to, in our view, as human decisions defy prediction. But we think markets are much better at weighing the extent of the damage now than they were two years ago. Many widely followed economic observers now also know restrictions’ impact is fleeting. In our view, stocks have recognised this since March 2020, when a new bull market began despite nearly the entire West being in lockdown.^[xvi] We think markets knew that even if restrictions returned—as they did in Europe in late 2020 and early 2021 and again this past December and January—they wouldn’t automatically pack the type of wallop from early 2020.^[xvii]

Restrictions could always hurt sentiment, as our research suggests stocks can fall for any or no reason in the short term. But in our view, the widespread recognition that COVID restrictions may be a headwind—but one with a fleeting impact—is further evidence of progress towards a post-COVID future.