Europe is back, baby!
After a near-death experience, the eurozone economy roars ahead.
Back in May, all hope seemed lost. The global financial market was suffering violent spasms as Greece and Spain looked ready to default on their debts. The euro plunged. Fear spread that austerity measures in Europe would pull the world's largest economy into a new recession, dragging America and the rest of the world down with it.
In that context, on May 26 I wrote a column urging investors to be bold and buy into Europe. The takeaway: A cheaper euro was exactly what Europe needed to regain its competitiveness. And that was sure to push European stocks higher.
The result: My call was within one day of the exact bottom for European stocks. Since May 26, Europe 350 iShares (IEV) is up a whopping 14.5% compared with a 3.5% gain for the S&P 500 over the same period. But what lies ahead? Can the gains continue?
With the successful conclusion of Europe's bank stress test results, and a batch of solid economic data coming through, it certainly looks that way. The Conference Board's Leading Economic Index for the eurozone increased 0.5% in June to 111.2 following a 0.3% in May and a 0.8% increase in April. Jan-Claude Manini, the Conference Board's senior economic for Europe, noted that the "recovery is unlikely to falter in the short-term." The rise in the index was driven by interest rates, the money supply, economic sentiment, and stock market performance.
As for the bank stress tests, while they were far from perfect, they did shine some light in an area where there was murkiness. Because of the tangled web of bank regulators in the eurozone, investors didn't have much insight into which banks were strong, which were weak and which were on the verge of collapse. With a dearth of information, bank stocks in particular and European equities in general were hammered in April and May.
But now perceptions have changed. The tests were certainly too lenient, but some of the fear of total rot on the books of European banks has been lifted. And as a result, stocks in Europe are moving higher. Of the 91 banks tests, only seven failed (mostly smaller Spanish thrifts) and 12 barely scraped through (including Allied Irish Bank and Germany's Postbank).
The total capital shortfall and the banks that failed amounted to $4.5 billion, and investors are showing a willingness to help fill the gap. JC Flowers, a U.S.-based buyout firm, put $580 million dollars into Civica, a Spanish bank that failed the test. This is a fantastic sign of confidence and marks the first time one of the Spanish "cajas" -- institutions much like U.S. savings and loans -- sought outside capital.
There was other good news out of Europe last week, helping to dissipate some of those double-dip concerns for now.
The eurozone composite purchasing managers' index increased from 56 to 56.7 -- far better than the consensus estimate of a drop to 55.2. You can see the tiny hook up in the blue line on the chart above. The improvement was driven by strength in manufacturing and services.
This is a sign that the improvement in economic activity is spreading from export-oriented industries to domestically focused services businesses. The result also marked the eighth consecutive monthly rise in the employment index as new jobs are created.
In Germany, business confidence reached a three-year high as a "party mood" spreads throughout the country according to Hans-Werner Sinn, president of the Ifo Institute which conducts the survey. The business climate survey increased to 106.2 from 101.8 in June -- the largest increase recorded since German reunification in 1990.
In Italy, the ISAE research institute of Italian consumer confidence increased to 105.6 for July from 104.5. This was well above analyst expectations for a drop to 103.9. And this came in the midst of the European debt crisis and shaky global markets. Think about where confidence can go now that some of fear has passed.
In the United Kingdom, the economy expanded by 1.1% in Q2 -- nearly twice as quickly as economists expected. This represents the best growth in four years. The increase was due to broad-based strength, with the manufacturing, services, and construction sectors all participating.
While there is certainly the potential for a renewed slide in business activity and confidence should the European sovereign debt situation suffer another setback, for now things are looking up. And that should continue to benefit stocks in the region.
Disclosure: The author does not own or control a position in any company mentioned. He can be contacted at firstname.lastname@example.org. Feel free to comment below.
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