What the Eurozone’s ‘Flat’ Q4 Obscures

Eurozone gross domestic product (GDP) was flat in Q4, according to the preliminary reading, and as usual, most publications we follow focussed on that factoid and (in our opinion) read far too much into it.^[i] Headlines we follow claimed the bloc is stagnating, the European Central Bank (ECB) needs to cut interest rates, manufacturers are too exposed to Red Sea shipping problems—all the pessimism we have long seen toward the region. In our view, reality is more nuanced, and we think there is a simple way investors can cut through the fog to see it: Tune down eurozone GDP itself.

Yes, the eurozone is a large, important chunk of the global economy.^[ii] But in our view, all eurozone GDP tells you is how 20 nations’ growth rates netted out in a given quarter. These nations may share monetary policy and regulations, but based on our research, each has its own fundamental backdrop, industry makeup and unique local conditions affecting how things go. Looking only at the bloc’s headline growth can obscure these trends, in our view. And when eurozone GDP is flat, its GDP can be even more of a distraction, since logic dictates not every member-state was flat—indicating that national results are probably a hodgepodge of good and bad. This hodgepodge is arguably more telling, in our view.

So let us look at the hodgepodge and start with the weakest link: Germany. Its Q4 GDP shrank -0.3% q/q, but Q3 was revised up to flat, leaving economists we follow globally grappling with whether to call this a recession (a prolonged period of contracting economic output).^[iii] This is a conundrum because one common definition of a recession is two sequential GDP contractions. Germany doesn’t meet this criteria presently, but its GDP is down from a high over a meaningful stretch of time. In our view, this shows the inherent flaws with using two sequential GDP contractions to define recession. Germany’s trajectory over the past five quarters is a -0.4% q/q contraction in Q4 2022, 0.1% growth in Q1, flat in Q2 and Q3 and now down -0.3% in Q4.^[iv] To us, there is a decent argument here for seeing the country down from its high for five quarters straight, noting it hit a new low in the most recent reading, and calling it a recession. We are also willing to entertain arguments the other way, but we think this is a sideshow from an investment standpoint. The economic decline began well over a year ago, on the heels of 2022’s global bear market—which hit German stocks quite hard.^[v] Given our research finds stocks have a long history of pre-pricing recessions, we think it is fair to say the bear market spent some time discounting a high likelihood of German economic trouble as chatter about natural gas shortages hampering heavy industry ramped up.^[vi] Since then, German stocks have recovered even as the economy floundered.^[vii] They hit new highs in euros in December and again last week.^[viii] Seems to us stocks are saying the end is closer than the beginning.

French stocks are also at new highs in euros, which might surprise considering France’s flat Q4 GDP reading was the fourth 0.0% q/q in the past five quarters, with only Q2’s 0.7% growth bucking the trend.^[ix] Analysts’ consensus forecasts for Q1 presently aren’t great, in our view, as economists begin attempting to tally the economic costs of farmers’ escalating protests over EU farm regulations’ high costs and effect on competition.^[x] That is a topic for another day, but we think the key for now is that here, too, markets are well aware. They have likely seen the tractor blockades on various highways, and they have probably seen the flash purchasing managers’ indexes (PMIs, monthly surveys that track the breadth of economic activity) showing contraction this month.^[xi] But they have probably also seen contracting PMIs diverge from flat GDP for several months now, and they have likely seen France’s robust history of protests bringing only a limited, temporary economic impact.^[xii] If the market is sending such a powerful signal that better times lie ahead, we think investors are wise to heed that rather than get caught up in what is going on right now and in the recent past. Stocks look forward, roughly 3 – 30 months out, in our experience.

Lastly, and perhaps more interestingly, long-derided southern Europe did the heavy lifting in Q4. Yes, in what some may see as a shocking role reversal, the countries once considered the eurozone periphery—Italy, Spain and Portugal—outgrew the core at 0.2% q/q, 0.6% and 0.8%, respectively.^[xiii] The fun thing here, in our view, is the old monetary policy debate we have seen over the years always held Germany needs and wants high rates whilst southern Europe would benefit from low rates, and this split makes the eurozone and its common monetary policy untenable in the long run. Yet here we are, with the south doing quite well despite high rates. Now commentators we follow argue Germany needs that break. Maybe everyone is focussing too much on the ECB here and ignoring that rates are only one variable affecting economic results? We will concede high rates probably contributed to Germany’s construction decline, which played a role in Q4’s contraction, but that is a region-wide headwind that other nations still managed to outgrow.^[xiv] In our view, painting with broad brushstrokes won’t create a clear picture.

So, pockets of weakness and pockets of strength—typical eurozone, based on our research. Thus far, amongst the countries reporting, there are more strong than weak. Maybe that changes, but with stocks seemingly looking past the eurozone’s well-known issues, we think the smart move for investors is to do the same. Our research suggests it takes big, new, deeply negative surprises to sink stocks anew, and what we have here is the same old cud markets have chewed for over two years now. Stocks appear to have moved on. If you are investing for long-term growth, we suggest doing yourself a favour and following their lead.