Across the Great (Sentiment) Divide

A recent spate of soft data releases suggests February and March weren’t kind to the UK and German economies. This isn’t 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. But deeper digging reveals a useful nugget for investors. While both countries fared about the same, headlines amplified Germany’s struggles—dubbing them a downturn in the making. Meanwhile, they downplayed the UK’s, waving off “the blip.” In our view, these divergent receptions highlight the fact sentiment towards the eurozone has significant room to improve—bullish for stocks there.

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

Yet while the UK and German growth pictures look largely the same, media interpretations differed wildly. Coverage in the UK noted broad weakness for February and March, but the analysis and interpretation was sanguine. Instead of projecting weakness ahead, they 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 compare this measured reaction to how folks greeted Germany’s wobble. There, coverage 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. “Peak growth” is over on the Continent, this story goes: As the ECB-fueled 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. Folks seemingly forget short-term data are volatile and one-off factors 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 also probably 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 signaling trouble, this likely just highlights the fact bumps and dips along a broad upward trend are common. While it is always possible a less-than-stellar February and March will turn out to be the start of a bigger 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—all the data here are backward-looking. Extrapolating them into the future doesn’t make sense. Similarly, combining a few recent weak German data points with a few from elsewhere in the eurozone—as some have attempted to do with disappointing French and Italian February economic data—is unconvincing, in our view. Backward-looking metrics don’t become more predictive when lumped together.

That folks made much of weak German data while mostly taking weak British data in stride suggests to us the eurozone expansion still isn’t getting the credit it deserves. This despite the fact forward-looking indicators like the eurozone yield spread (and those new orders) still point positively. Skepticism is understandable 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 linger. This hangover leads many to doubt quite strong eurozone fundamentals—and read a lot into what mostly seems like normal data variability.

Stocks move on the gap between expectations and reality—and the bigger the gap, the higher the likelihood of a positive surprise as fears fail to materialize. Presently, we see expectations lagging further behind reality in the eurozone than elsewhere in the developed world, which we think should boost eurozone stocks over the foreseeable future.