What Q3 Eurozone GDP Growth Tells Investors

Surprise! After the release of US Q3 GDP last Thursday, the eurozone’s four biggest economies followed suit, with Germany stealing most headlines thanks to Q3 growth beating contraction projections and rebuking widespread recession chatter. Yet most didn’t cheer the better-than-estimated numbers. Instead, many warned the surprise beat was a passing anomaly before more troubling times ahead—especially given persistent elevated inflation. While last quarter’s data are old news, this dour reaction reeks of the pessimism of disbelief—the foundation of a recovery, in our view. 

First, the numbers: Eurozone GDP grew 0.2% q/q in Q3, topping expectations of 0.1%.^[i] Of the 19 eurozone nations, 9 reported as of November 1, 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. The findings were also mixed but growthy in France (0.2% q/q) and Spain (0.2% q/q). For the former, gross fixed capital formation contributed while household spending stagnated; for the latter, tourism boosted the services sector as the country relaxed COVID restrictions. However, the Continent’s largest economy, Germany, grabbed most attention, growing 0.3% q/q. Though the first estimate doesn’t share a component breakdown, statistics agency Destatis credited private consumption expenditure for Q3 growth.

In a vacuum, the data were fine—most were slower than Q2 growth rates, but they largely beat expectations. However, “yeah, but” was the typical reaction, as most coverage found reason to be downcast. In our view, that is evidence of the pessimism of disbelief—a phenomenon in which investors emphasize negatives everywhere, even in positive news.

Consider the following common themes we saw in reaction to German GDP:

• Yeah, German GDP grew when everyone expected contraction—but October inflation (11.6% y/y) also outstripped estimates, so this is just the calm before the storm.
• Yeah, German growth has held up so far—but its export-oriented economy has been exposed by COVID and Russian energy reliance, so tough times are coming.
• Yeah, Germany may have filled up its gas-storage reserves and appears able to weather this winter—but energy security issues remain, and they pose a bigger problem for winter 2023 – 2024.

We aren’t ignoring the headwinds facing Germany or Europe—or the associated 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. Germany in particular is vulnerable since shortages would hurt its large chemical industry, which relies on natural gas for energy and feedstock. 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. However, we think the focus on prospective negatives and quick dismissal of any good economic news reveals how dour sentiment is today.

That is notable for investors, in our view, since markets don’t 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. That means 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. German recession concerns picked up steam after Russia’s vile invasion of Ukraine earlier this year, as investors feared draconian EU sanctions on Russian energy would kneecap Germany’s economy. Yet reality hasn’t been quite as bad as first 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.

But Germany hasn’t been passive. The country has filled up its gas reserves for the winter ahead of schedule and reached new agreements with other sources for future supply. 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.

While 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. Though the chemical & pharmaceuticals product category has contracted in six of eight months, electrical & computing devices manufacturing has grown in seven of eight months.^[iii] Note, these output figures are adjusted for inflation. 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 the figures will be old news to forward-looking stocks, whose shallow bear markets this year are consistent with a mild recession. Eurozone stocks have fallen as much as -23.4% this year, while German stocks are down -21.6% year to date (returns in euros to remove currency skew).^[iv] In our view, stocks aren’t waiting for official confirmation of recession—they have already pre-priced that 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 is the baseline expectation, sapping most of its surprise power, in our view. For markets, ongoing pessimism in the face of today’s mixed reality can be the foundation of a recovery.