The Eu­ro­zone’s sus­tain­able re­cov­ery

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Eu­ro­zone re­tail sales reg­is­tered their first month-on­month fall in five months in Fe­bru­ary, prompt­ing fears that Europe’s con­sumer-driven re­vival may be fal­ter­ing.

Since last May the price of oil has fallen -32% in euro terms, lift­ing real wages by 2% and boost­ing con­sumer pur­chas­ing power across the eu­ro­zone. Over the last three months, how­ever, oil has re­bounded 22% from its Jan­uary low, erod­ing some of the Euro­pean con­sumer’s pur­chas­ing power gains.

Hap­pily, there are sev­eral rea­sons to be­lieve the re­cov­ery will con­tinue.

Eu­ro­zone money sup­ply is now ex­pand­ing rapidly.

The M3 broad money mea­sure grew at its fastest pace since April 2009 in Fe­bru­ary. Ad­mit­tedly, M3 on its own is not the most re­li­able in­di­ca­tor of re­fla­tion in ac­tion.

A bet­ter guide is the in­fla­tion-ad­justed M3 gap—the dif­fer­ence be­tween the M3 stock of money and the trend level of M3 stock. In re­cent months this gap has be­gun to close for the first time since 2011, in­di­cat­ing that dis­in­fla­tion­ary pres­sures have abated.

The rise in M3 has been pro­pelled partly by ag­gres­sive Euro­pean Cen­tral Bank pol­i­cy­mak­ing even be­fore quan­ti­ta­tive eas­ing kicked off last month, partly by the eu­ro­zone’s cur­rent ac­count sur­plus, and partly an emerg­ing re­cov­ery in lend­ing to the pri­vate sec­tor—no­tably in Ger­many—now that banks have delever­aged and re­cap­i­tal­ized.

How­ever, a break­down of eu­ro­zone money sup­ply also shows en­cour­ag­ing signs. With yields on time de­posits unattrac­tive thanks to the ECB’s ul­tra-loose pol­icy, con­sumers and busi­nesses have been shift­ing money out of fixed term ac­counts and into de­mand de­posits. The up­shot is a rapid in­crease in the amount of liq­uid cash in the sys­tem that can be called on im­me­di­ately to fund ei­ther con­sump­tion or in­vest­ment—usu­ally a sig­nal of gath­er­ing re­fla­tion­ary pres­sure.

Con­struc­tion ac­tiv­ity



is pick­ing up in Ger­many.

The Ger­man con­struc­tion PMI recorded its sec­ond con­sec­u­tive monthly ex­pan­sion yes­ter­day to 53.3. New con­struc­tion or­ders rose for the first time in three years, while sup­pli­ers’ de­liv­ery times de­te­ri­o­rated as they strug­gled to keep up with ris­ing de­mand and in­put cost in­fla­tion rose to a three-month high.

As a re­sult, the 12-month out­look is the most op­ti­mistic for more than four years. Con­struc­tion is strong across all three sec­tors of the mar­ket, but hous­ing is the best per­former, sug­gest­ing that the health of de­mand for new homes will sup­port Ger­man con­sumer spend­ing.

Ital­ian in­vest­ment sank to its low­est level for more than 20 years in 4Q14. Now how­ever, there are signs that things are chang­ing. In March, busi­ness con­fi­dence—a lead­ing in­di­ca­tor for in­vest­ment— hit its high­est level since June 2008. Mean­while, the weak euro is at­tract­ing in­ter­na­tional in­vestors to Italy. ChemChina’s head­line-grab­bing pur­chase of Pirelli last month was no one-off deal. Ac­cord­ing to data com­piled by Bloomberg, China has spent US$14 bln on ac­qui­si­tions in Italy over the last 12 months, more than in ei­ther the US or the UK.

Cheaper oil, mon­e­tary pol­i­cy­mak­ing that is now firmly ahead of the curve, greater con­fi­dence in the eu­ro­zone’s bank­ing sys­tem fol­low­ing last year’s As­set Qual­ity Re­view, emerg­ing loan de­mand, and a long-awaited pick-up in Ger­man con­sumer de­mand should all com­bine to cre­ate a sus­tain­able ac­cel­er­a­tion in the eu­ro­zone econ­omy. A ma­jor re­bound in the oil price could still scup­per the re­cov­ery, but that looks im­prob­a­ble.

De­spite the strong rally in eu­ro­zone stocks so far this year,




in US dollar terms the MSCI EMU in­dex is still close to the bot­tom of its 20-year trad­ing range against the MSCI US. Given the eu­ro­zone’s pos­i­tive fun­da­men­tals, we rec­om­mend that global in­vestors con­tinue to main­tain un­hedged over­weight po­si­tions in eu­ro­zone stocks ver­sus the US.

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