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European Recession Crisis

Is Europe Finally Recovering?

Posted August 13, 2013 at 4:26PM

The euro zone’s economy may finally be rising above the waterline after the longest recession of its short 14 year history.

europe banking
Source: AFP/Getty Images

The latest data set due out tomorrow is expected to show the 17-nation euro zone (those nations officially using the euro currency) enjoyed a GDP growth of 0.2% in Q2. This being the first quarterly GDP growth after a string of 6 quarterly contractions in a row, the declaration can finally be made that the Eurozone’s 1.5-year recession is finally over.

The shift in economic winds started in the U.S. seems to be blowing Europe’s sails too, as Nick Kounis, head of macro research at ABN Amro Bank in Amsterdam, noted to Bloomberg:

“The external environment is really getting better, led by signs that U.S. demand is picking up. The second quarter should mark the end of the recession in the euro area.”

So is this a good time to invest in Europe? Or are there still some jagged rocks lurking in the shallow waters?

Still Choppy

Kounis tempers our enthusiasm with his expectation that “the recovery will be excruciatingly slow.” “We’re not getting the champagne out yet,” he admits.

One reason the recovery will be painfully slow is that progress seems to be concentrated in just a handful of nations, the leader of the pack being Germany. While Germany is expected to top tomorrow’s Q2 GDP ranks with 0.75% growth, Spain is still contracting by -0.1%, Italy by -0.2%, and Greece is still hemorrhaging by -4.6%.

The European Central Bank is not convinced of smooth sailing ahead, having recently cut its interest rates to their lowest level in its history. Calling Europe’s recovery “tentative”, ECB president Mario Draghi has committed to keeping interest rates this low and lower for “an extended period”, indicating just how fragile the recovery is. After all, one good quarter out of 7 does not a recovery make, especially when each nation seems to be at a separate stage of recovery.

On the whole, European employers seem to be hiring again. The largest temporary worker agency, Adecco SA (OTC: AHEXY), reported increased profits in Q2, boosting its outlook for the zone’s labor markets. Much of the newest jobs likely originated in the manufacturing sector, which expanded for the first time in two years, as indicated by a recent purchasing-managers survey.

Yet these job increases are mainly concentrated in the most heavily industrialized nations, while other euro zone countries still suffer massive unemployment among their youth – notably Spain and Greece, with 56% and 60% of their youth out of work, respectively.

Slowing the euro zone’s progress is the lack of credit and liquidity, with lending to corporations and individuals falling in June by the largest amount ever in any single month.

Slowing it all the more, banking reforms are still being delayed – reforms that include ECB oversight of all euro zone banks, the initiation of a “single resolution mechanism” for dealing with failing banks within the euro zone (basically a single set of banking rules for all euro countries to abide by), and new deposit guarantees have still not been voted on.

In this scenario of the strongest horses dragging the exhausted horses along, insufficient lending and slow reforms prompted Nicholas Spiro, managing director of Spiro Sovereign Strategy, to downplay recovery expectations.

“Talk of an economic recovery, to say nothing about a sustainable one, when domestic demand is still contracting, government debt levels continue to surge and the economic and institutional reform agenda is unravelling, is wide of the mark,” he candidly expressed to Bloomberg. “Germany may be pulling ahead, but the bloc’s other main economies, including France, remain in dire straits.”

 

Pick Your Investments Carefully

This should give us an idea of how to invest in Europe over the coming year or two. You can’t simply pick any large corporation anywhere, as the economic recovery in Europe is not uniform across all euro zone nations. A quarterly improvement in GDP is merely an overall rating, but the specific operating environments of each corporation can be recovery-stalling.

The banking sector is pretty much out of the question, since it is still under reform with no end yet in sight. Liquidity is still tight, and when banks don’t lend, they don’t earn. To make matters worse for the banks, the ECB has only just begun adopting a highly accommodative policy of low interest rates, which will severely constrict bank revenues for years to come.

Exporters should be the focus of our investment for now, as companies with large export activities deal with non-European nations whose recoveries are fairing better. China, the U.S., and the U.K. are much further along than continental Europe, supported recently by China’s increased July industrial output and America’s GDP growth of 1.1% in Q1 and 1.7% in Q2.

Likely the two European export sectors that will benefit most from an improving global recovery are energy and motor vehicles, including:

  • Energy companies Royal Dutch Shell (NYSE: RDS-A) of the Netherlands, with a 5.59% dividend yield; British Petroleum (NYSE: BP) of the U.K., yielding 5.26%; and Gazprom (OTC: OGZPY) of Russia, with a high octane 7.15% dividend yield.

  • Auto makers Volkswagen (OTC: VLKAY), which also produces Audi; Daimlerchrysler (OTC: DDAIF), which also produce Mercedez-Benz; and BMW (OTC: BAMXF).

If you’re looking to power your portfolio and drive its returns with some European components, avoid the banks, and stick with the exporters.

Joseph Cafariello

 

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