With fresh eyes

Sitting day in, day out behind our computers and watching the economic day flow past provides a good deal of feeling for the overall trend, but it also tends to feed into some natural cognitive biases. Like the proverbial frog in hot water, this constant economic data flow means we analyse the most recent data – an incremental change in temperature, in this analogy - and could easily miss the big picture; the water, in which we are collectively sitting, is about to boil. This isn’t only a phenomenon with economic data; it’s also the story of asset prices across the globe. Prices move a bit higher due to , and we simply ignore the absolute level of prices.

In a report last week, we reported that EU economic data was mixed, which means some was better than forecast and vice versa. This is true enough, but if we step back, squint and look at the average numbers coming out of the bloc, they are pretty terrible. There were some modestly positive Gross Domestic Product growth numbers released, which may cause a sense of relief, but it doesn’t stand a second look. GDP is a measure of past performance, quite lagged and notoriously inaccurate. That’s like looking in a foggy rear-view mirror to make sure you’re driving in the right direction. If we zoom out and view the data with fresh eyes, we would make the following case.

EU Purchasing Managers’ Index data has shown a systematic manufacturing decline; only France has eked out numbers just above the 50 ‘neutral-level’. Services PMI data shows some very modest expansion, but it’s near the weakest level in six years. Bloomberg’s Indicator of Activity Report – a composite of a variety of sources including European Commission Consumer Confidence - shows the Euro Area is just near zero; for reference, it was 3.5 two years ago. Lastly, Bloomberg’s estimate of the Euro Area Output Gap – the difference between actual growth and potential growth – shows that it is approaching zero. Essentially this means the current modest level of GDP growth (1.1% was the last reading) is near the potential growth rate.

Given that rather bleak picture, it’s surprising to see the price/earnings ratio – a measure which compares stock prices versus underlying earnings and is used as a gauge of relative value – of the Euro Stoxx 600 rising over the past year. There is no doubt the European Central Bank’s negative interest rates have reduced the cost of funding for firms, but one also needs to consider the commensurate decline in earnings. It’s only when viewed through the prism of fundamentals that we can see this EU asset appreciation is unjustified.

Bottom line: It’s helpful to re-examine our previous views with fresh eyes occasionally. While we haven’t been upbeat about the EU’s fundamentals for some time, this context makes current EU asset valuations seem a bit absurd. In that light, we wouldn’t anticipate the EUR to break its devaluation trend against the Greenback anytime soon. Our devil’s advocate question is always ‘what would change our view’? Whatever it is we haven’t seen it yet!

Euro Stoxx 600 P/E

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The week ahead

GBP

Short-term volatility for the Pound has plummeted following a new three-month Brexit extension decision and a December general election. The trade-weighted Sterling Index nudged 0.8% higher last week as the Brexit pause took hold. On Thursday, The Bank of England will update its official interest rate, followed by a press conference with Governor Mark Carney. Expectations are for an unchanged policy rate and a reiteration that Brexit clarity will be required before any significant policy tools are used.

  • UK Services PMI is released on Tuesday morning, and a contraction in the UK’s most significant sector is expected for the second month in a row. The contraction is forecast to be marginal at 49.6 (50.0 is neutral).
  • The BRC Retail Sales stat will also be out on Tuesday, and an improvement from last month’s -1.7% is expected, but still remaining in negative territory at -1.4% year-on-year. A decline in Retail Sales for October will mark three consecutive contractions.

USD

The trade-weighted US Dollar Index extended its decline, reaching 10-week lows and crossing below the 200-daily moving average last week. Increased market sentiment surrounding the US-China trade war has been a significant driver of recent Dollar weakness, prompting capital to flow out of the safe-haven currency and into riskier assets. The 200-daily moving average could provide significant resistance for any rebound in the Greenback this week. 

  • The US ISM Non-Manufacturing PMI will be released on Tuesday afternoon, and an improvement from last month is expected at 53.5. This key gauge has taken a steep decline this year, and although it still shows expansion, the measure is rapidly approaching the neutral 50.0 mark.
  • On Friday, preliminary University of Michigan Consumer Sentiment data will be released, and expectations are for an increase to 96.0 from the previous reading of 95.5. The preliminary reading tends to have more of an impact than the revised version released two weeks later.

EUR

The Euro Index reached two-month highs last week as it crossed the 50-daily moving average but fell short of reaching the 100-daily moving average. EUR/USD tested the 1.1179 barrier again last week but failed to break through the resistance level. New European Central Bank President Christine Lagarde is due to make her first speech as Chief on Monday evening while European Commission Economic Forecasts will be released on Thursday morning.

  • On Monday morning, Manufacturing Purchasing Managers’ Indexes from the Eurozone’s largest economies were released, all of which beat or met expectations. However, all but one country posted a contractionary reading – France.
  • Wednesday will see the release of the Services PMI’s from the Eurozone’s largest economies. Unlike the manufacturing sector, services readings are all expected to expand.

Also out on Wednesday is month-on-month Retail Sales for the Eurozone and expectations are for a slight uptick of 0.1%, down from last month’s 0.3% reading.