Cyprus is lovely this time of year. With the green shoots of spring starting to emerge from the winter months it’s a time of new beginnings. Perhaps fitting then that Mario Draghi, President of the European Central Bank (ECB), should choose the island to unveil his upgraded growth forecasts for the eurozone region. Following years of near economic stagnation, GDP growth is estimated to rise by 1.5% for this year and 1.9% for 2016, up from 1.0% and 1.5% respectively. Draghi’s key hope is that the re-appearance of growth will deflect the deflationary scare that pre-occupies markets and investors alike.
There are solid grounds for thinking those growth forecasts might be on the conservative side. The sharp decline in the oil price, the euro’s devaluation against the US dollar - over 20% at the time of writing since its peak in May 2014 - and Draghi’s attempt to reflate the eurozone’s balance sheet mean that the region has undergone seismic shifts since the beginning of the year. Shares have already priced in some of the good news. In February alone the MSCI Europe index rose by a heady 6.9% in local currency terms, although that reduces to a little over 3% in sterling terms.
The rise in eurozone cyclicals since the start of the year shows the market is already aware of the most obvious sectors to benefit from the double tailwinds of a weaker euro and oil price. Airlines, automobiles, food producers and retailers are the most obvious candidates, as well as financials and engineers. But where’s the real evidence that the green shoots of economic recovery are appearing? While the full extent of a devalued currency is yet to be fully known, export data look encouraging. According to Eurostat, the European Commission’s statistics bureau, exports for the eurozone region are up by 0.8% quarter-on-quarter. Year-on-year statistics show an impressive 4.1% for the fourth quarter ending 2014.
Yet, good news has not yet properly fed through to the analyst community. While the scribblers have been keen to downgrade the obvious company ‘victims’ - those oil majors directly hurt by Brent crude’s decline - the positives have yet to be fully reflected in earnings upgrades. This is largely due to the unquantifiable nature of by how much exactly a declining oil price and euro affect profitability. Yet, we do have some idea. According to estimates, a 10% drop in the euro (against other major currencies) could boost corporate earnings in the eurozone area by as much as 7%. That’s a very high correlation by any measure. Watch this space then, come April, when first quarter results, (especially for those companies where the cost base is in euros but sales are outside of the region) start to be unveiled.
What of the imminent headwinds for the region? Talk of a permanent deflationary spiral remains top of the list, with many investors still to be convinced that the eurozone will not follow Japan’s ‘lost decade’ period. Surplus capacity, particularly in Spain, and high levels of eurozone unemployment are still cause for concern, although Germany’s unemployment rate remains at a record low of 6.5%. But signs of an improving consumer’s lot are already in evidence. This is particularly evident in the growth in European car sales – up 8% for February alone. Furthermore, real wages are increasing. IG Metall, Germany’s Industrial Union of Metalworkers, recently awarded their workers a pay rise of 3.4% - quite substantial given inflation in Germany is zero.
Of course, no one can permanently silence the bears on Europe – we’ve been used to their talk of anaemic growth and deflationary spirals for long enough. But if earnings revisions come through strongly in the spring and subsequent months, it should be sufficient to silence them for some time to come.
Kevin Lilley is portfolio manager of Old Mutual European Equity Fund, Old Mutual Global Investors