Surprise! After the release of America’s Q3 gross domestic product (GDP, a government-produced measure of economic output) last Thursday, the eurozone’s four biggest economies followed suit. And, rebuking widespread recession (broad, economy-wide decline in activity) chatter, Germany stole most headlines in financial publications we monitor thanks to Q3 growth beating contraction projections. Yet most coverage we observed didn’t cheer the better-than-estimated numbers. Instead, we saw many analysts warn the surprise beat was a passing anomaly before more troubling times ahead—especially given persistent elevated inflation (rising prices economy-wide). Whilst last quarter’s data are old news, we think this dour reaction reeks of the pessimism of disbelief, a psychological phenomenon in which investors emphasise bad news and look for negatives in developments that would otherwise appear good. These conditions are often the foundation of a recovery, based on our research.
First, the numbers: Eurozone GDP grew 0.2% q/q in Q3, topping expectations of 0.1%.[i] Of the 19 eurozone nations, 9 have reported data as of 1 November, with 3 (Belgium, Latvia and Austria) contracting.[ii] But the common currency bloc’s biggest economies all expanded. Italy grew fastest (0.5% q/q), beating flatline expectations, as national statistics bureau ISTAT noted service sector gains offset contractions in industry and agriculture.[iii] The findings were also mixed but growthy in France (0.2% q/q) and Spain (0.2% q/q).[iv] For the former, France’s National Institute of Statistics and Economic Studies (INSEE) reported gross fixed capital formation contributed whilst household spending stagnated; for the latter, tourism boosted the services sector as Spain relaxed its COVID restrictions.[v] However, the Continent’s largest economy, Germany, grabbed most attention amongst financial publications we monitor, growing 0.3% q/q.[vi] Though the first estimate doesn’t share a component breakdown, statistics agency Destatis credited private consumption expenditure for Q3 growth.[vii]
In a vacuum, we think the data were fine—most were slower than Q2 growth rates, but they largely beat analysts’ consensus expectations.[viii] However, we found most coverage expressed reason to be downcast, as it acknowledged the positive news, yet added caveats: a yeah, but response. Based on our research, that is evidence of the pessimism of disbelief.
Consider the following common themes we saw raised by experts in reaction to German GDP:
We agree Germany and Europe likely face economic headwinds—including hardships for households and businesses. Potential energy shortfalls could lead to rationing, which likely would hit the economy hard and increase the chances of recession, based on our historical studies. We think Germany in particular could be vulnerable since shortages would likely hurt its large chemical industry, which relies on natural gas for energy and feedstock.[x] It is possible, too, that Germany’s relatively larger GDP weighting to heavy industry and exports drives slower growth in the distant future, though that long-term projection is unprovable now, in our view.[xi] However, we think the widespread focus on prospective negatives and quick dismissal of any good economic news reveals how dour investor sentiment is today.
That is notable for investors, in our view, since we don’t think markets view news as good or bad the way most regular people do. Rather, how people feel about conditions now and in the near future—and how reality aligns with those expectations—matters more to stock prices, based on our analysis. That implies even not-so-good news can boost markets (e.g., weak GDP growth exceeding forecasts for a sharp downturn).
Consider, too: European recession forecasts aren’t new according to our coverage of financial headlines this year. We saw German recession concerns pick up steam after Russia’s vile invasion of Ukraine, as investors expressed concern that draconian EU sanctions on Russian energy would kneecap Germany’s economy. But, in our view, reality hasn’t been quite as bad as forecast. Yes, the EU imposed sanctions, and Russia retaliated by reducing gas volumes. Falling gas supply has hurt Germany, forcing some of its plants to make big production cuts—and some may even have to go offline, based on our observations.[xii]
But Germany hasn’t been passive in this environment. The country has filled its gas reserves for the winter ahead of schedule and reached new agreements with other sources for future supply.[xiii] Berlin is also keeping three nuclear power plants online beyond this year after scheduling to shut them down, and businesses and households are participating in conservation efforts.[xiv]
Whilst we don’t have a complete picture of sanctions’ impact on heavy industry’s German GDP contribution, the monthly industrial production report reveals a mixed bag. Manufacturing has grown on a monthly basis in five of eight months this year, but output across industries varied.[xv] Though the chemical & pharmaceuticals product category has contracted in six of eight months, electrical & computing devices manufacturing has grown in seven of eight months.[xvi] Note, these output figures are adjusted for inflation, which implies elevated prices aren’t skewing the results.
The second estimate of Q3 GDP will provide a more detailed picture of the magnitude of sanctions’ impact on German heavy industry. But by then, we think the figures will be old news to forward-looking stocks, whose shallow bear markets (usually defined as prolonged market downturns of -20% or more due to fundamental causes) this year are consistent with a mild recession, based on our analysis. Eurozone stocks have fallen as much as -23.4% this year, whilst German stocks fell down -21.6% year to date through October (returns in euros to remove currency skew).[xvii] In our view, stocks aren’t waiting for official confirmation of recession—they have already pre-priced that economic weakness to a very great extent and are looking ahead.
It is possible economic developments turn materially worse from here, but at this point, a German recession appears to be the baseline forecast, sapping most of its surprise power, in our view. For markets, we think ongoing pessimism in the face of today’s mixed economic reality can be the foundation of a recovery.
[i] Source: FactSet, as of 2/11/2022.
[ii] Source: Eurostat, as of 31/10/2022.
[iii] Source: Istat, as of 2/11/2022.
[iv] See note i.
[v] Source: INSEE, as of 2/11/2022 and “Spain's Quarterly Growth Slows to 0.2%, Missing Expectations,” Joanna Jonczyk-Gwizdala and Belen Carreno, Reuters, 28/10/2022. Accessed via U.S. News & World Report.
[vi] Source: FactSet and the World Bank, as of 2/11/2022. German GDP, in constant 2015 US dollars, in 2021.
[vii] Source: Destatis, as of 28/10/2022.
[viii] See note i.
[x] “German Chemical Industry Has No Gas Left to Cut, Warns Association,” Patricia Weiss and Miranda Murray, Reuters, 19/7/2022. Accessed via Yahoo! Finance.
[xi] Source: The World Bank, as of 2/11/2022. Statement based on exports of goods and services and manufacturing as share of GDP for Germany compared to France, Italy and Spain.
[xii] “Rocketing Energy Costs Are Savaging German Industry,” Anna Cooban, CNN, 28/10/2022.
[xiii] “German Gas Reserves More Than 90% Full Despite Russian Supply Cut,” Staff, Associated Press, 20/9/2022.
[xiv] “Germany Extends Lifetime of Remaining Nuclear Plants,” Staff, Deutche Welle, 17/10/2022.
[xv] Source: FactSet, as of 2/11/2022.
[xvii] Ibid. MSCI EMU Index returns with net dividends, 31/12/2021 – 29/9/2022 and MSCI Germany Index returns with net dividends, 31/12/2021 – 31/10/2022. Both presented in euros. Currency fluctuations between the euro and pound may result in higher or lower investment returns. For reference, in GBP, MSCI EMU Index returns were -19.2% over the aforementioned timeframe whilst MSCI Germany Index returns were -19.8% during listed timeframe.
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