The Eurozone’s Still-Underrated Economy Grows

Data released last week showed the eurozone exited recession in Q1, at least by one common definition (two consecutive quarterly gross domestic product, or GDP, contractions).^[i] Headlines we read made much of it, with some economists claiming, “the worst is finally behind us.”^[ii] Maybe, but even the worst wasn’t as bad as anticipated, in our view. Furthermore, we find forward-looking stocks spied economic recovery ages ago.

Q1 eurozone GDP rose 0.3% q/q, following the prior two quarters’ sequential -0.1% dips. (Exhibit 1) We get the recession reference, of course. But calling it one seems like an exaggeration to us. Hence, when the Euro Area Business Cycle Dating Committee—the eurozone’s official arbiter of recessions—met in March, it deigned not to declare the “whisper below zero” two-quarter decline one, citing ongoing employment growth.^[iii]

Exhibit 1: Recent Eurozone GDP Readings

Source: Eurostat, as of 30/4/2024. Eurozone, Germany, France, Italy and Spain GDP, quarterly, Q3 2023 – Q1 2024. Eurozone Q4 GDP was revised down from flat.

Whatever you want to call the contractions, though, Q1 growth was broad-based, as GDP rose in all 10 countries reporting thus far.^[iv] Whilst Germany, the eurozone’s biggest economy, rebounded from a downwardly revised Q4, its federal statistics office noted household consumption fell.^[v] This reflects the “prevailing mood of economic gloom” in coverage.^[vi] Second-largest economy France was a bit cheerier with more detail, as consumer spending accelerated to 0.4% q/q from 0.2%, and business investment rose 0.5%, rebounding from a -0.8% drop.^[vii]

Southern eurozone nations were stronger still. Spain and Portugal, for example, each rose 0.7% q/q.^[viii] Some commentators we follow say Southern Europe is leading only because of stimulus and tourism, arguing this industry—roughly 10% of their economies—masks weakness more akin to France and Germany.^[ix] Whilst we think it is good to note variations, we don’t think pitting core and periphery against each other to rerun two-speed Europe arguments—as some commentators we follow are doing—is very helpful. Tourism contributes to GDP just like, say, car exports. Although a car is more tangible, one isn’t any better than the other, or more real. After all, most of the eurozone—and world—economy is intangible services.^[x] Nor are auto exports any more sustainable (in the literal repeatable sense) than tourism. Both are discretionary purchases, in our view, and cars are much more credit-sensitive.

As for stimulus, yes, EU recovery funds went disproportionately to its less well-off members clustered in Southern Europe.^[xi] But don’t overrate it. Spain’s €69.5 billion—doled out over 5 years—is peanuts compared to its €1.5 trillion (and growing) GDP.^[xii] Same with Portugal’s €13.9 billion given its €266 billion economy.^[xiii] We think it is more rounding error than driving economic force, especially because government stimulus is rarely spent smartly.

More importantly for investors, in our view, stocks started pre-pricing all this long ago. In 2022, we think they declined in anticipation of the economic implications of energy shortages—which hit Europe particularly hard. We found this, alongside geopolitical, inflation and rate hike projections, dragged down sentiment and drove the shallow bear market (fundamentally driven decline exceeding -20%).^[xiv] But the deep recession many economists we follow projected never came. With reality proving better than first thought, the eurozone’s bull market (generally rising equities) began in September 2022. (Exhibit 2) Then we found it kept going even as economic weakness eventually registered, looking further ahead to the recovery data are now starting to show.

Exhibit 2: Eurozone Stocks Moved Ahead of GDP

Source: FactSet, as of 30/4/2024. MSCI EMU returns with net dividends in euros, 3/5/2019 – 3/5/2024, and eurozone GDP, Q2 2019 – Q1 2024.

In our view, backward-looking GDP just confirms what stocks already fathomed. And we think the current alarm we see over growth going forward leaves plenty of room for reality to surprise positively and send stocks higher.