Across the Great (Sentiment) Divide

A recent spate of seemingly soft data releases suggests February and March weren’t kind to the UK and German economies. We don’t think this is noteworthy in and of itself—not every month can be a winner—and given we are midway through April, it may seem like old news to some. But deeper digging reveals a useful nugget for investors, in our view. Although both countries fared about the same, we saw many headlines amplifying Germany’s struggles—dubbing them a downturn in the making. Meanwhile, our observation of media coverage indicates many downplayed the UK’s, waving off what they perceived as a “blip.” In our view, these divergent receptions suggest sentiment towards the eurozone has room to improve—a factor we think could prove bullish for shares there.

We found the data similarities striking. UK February manufacturing output fell whilst overall industrial production managed a 0.1% m/m rise—but only because utility output increased, likely thanks to nasty weather.^[i] Both measures declined for Germany.^[ii] UK and German February construction activity contracted.^[iii] So did February trade in both countries—exports as well as imports, which represent domestic demand.^[iv] German retail sales fell in February.^[v] UK retail sales rose, but the sample cut off at February 24, before what many described as one of the worst winter storms in generations struck late in the month.^[vi] That delayed retail gloom until March, where preliminary data from the British Retail Consortium show sales turning south.^[vii] Lastly, Germany’s March composite Purchasing Managers’ Index (PMI) remained in expansionary territory but slipped from February.^[viii] The UK’s March services PMI did the same, whilst the manufacturing PMI inched up.^[ix] 

Although the UK and German growth pictures look largely the same to us, media interpretations appeared to differ wildly. Coverage in the UK generally noted broad weakness for February and March, but the analysis and interpretation seemed relatively sanguine. Instead of projecting weakness ahead, most observers largely blamed the weather and wrote it off as skewed. For example, in response to the underwhelming industrial production, manufacturing and construction figures, an economist for a manufacturing trade group said the report “looks more like a temporary wobble than a turn for the worse.”

We agree! But this measured reaction strikes us as far removed from how many headlines greeted Germany’s wobble. There, coverage frequently extrapolated weaker monthly data to a supposed broad eurozone slowdown, with some claiming a bloc-wide recession may be forming. This feeds into a long-running pessimistic narrative towards the eurozone, in our view. Based on our observation of news coverage, the popular story goes like this: “Peak growth” is over on the Continent—and as the ECB-fuelled quantitative easing high wears off and a US – China trade war waits in the wings, it can only get worse from here. Investors are rattled—and supposedly you should be, too!

To us, all this fretting highlights continued dour sentiment toward the region. Investors and pundits seemingly forget short-term data are typically volatile and one-off factors can loom large in any given month. For example, recent strikes by German metal and electrical workers, though over now, likely knocked February industrial output. Bad weather may also have had a lot to do with the broad weakness across both nations (and the eurozone as a whole—snow fell in Rome, after all).

Rather than signalling trouble, we believe this just highlights the fact bumps and dips along a broad upward trend aren’t unusual. Although it is always possible a less-than-stellar February and March will turn out to be the start of a bigger economic downturn, we don’t believe nearly enough evidence exists today to say this is probable. Moreover, except for PMIs’ new orders gauges—which indicate business expansion in both Germany and the eurozone^[x]—we believe all the data here are backward-looking. We don’t think extrapolating them into the future makes sense. Similarly, combining a few recent weak German data points with a few from elsewhere in the eurozone—as some apparently attempted to do with disappointing French and Italian February economic data—is unconvincing, in our view. We don’t believe backward-looking metrics become more predictive when lumped together.

That many appeared to make much of weak German data whilst mostly taking weak British data in stride suggests to us the eurozone expansion still may not be getting the credit it deserves. This despite the fact forward-looking indicators like the eurozone yield spread (and those new orders) still point positively.^[xi] Scepticism is understandable, in our view, given the eurozone hasn’t been growing as long as other major developed markets like the US and UK. Scars from the eurozone debt crisis and related recession from 2011 – 2013 might still linger. This hangover likely leads many to doubt eurozone fundamentals we believe remain quite strong—and read a lot into what mostly seems to us like normal data variability.

We believe equities move on the gap between expectations and reality—and the bigger the gap, the higher the likelihood of a positive surprise as feared developments fail to materialise. Presently, we see expectations lagging further behind reality in the eurozone than elsewhere in the developed world, which we think should boost eurozone shares over the foreseeable future.

[i] Source: Office for National Statistics, as of 16/4/2018.

[ii] Source: Federal Statistics Office, as of 16/4/2018. 

[iii] Sources: Office for National Statistics and Federal Statistics Office, respectively, as of 16/4/2018.

[iv] Ibid.

[v] Source: Federal Statistics Office, as of 16/4/2018.

[vi] Source: Office for National Statistics, as of 16/4/2018.

[vii] Source: British Retail Consortium, as of 16/4/2018.

[viii] Source: IHS Markit, as of 16/4/2018.

[ix] Ibid.

[x] Ibid.

[xi] Source: The Conference Board, as of 16/4/2018.