Data taking turn for the worse, a likely black eye for earnings
written by William L. Watts
Wednesday April 17, 2013
FRANKFURT — “Depression” isn’t the word usually used to describe the euro-zone economy, but it may become increasingly appropriate as hopes for a recovery give way to fears of an extended and destructive downturn that policy makers seem unable to halt.
“Unemployment is at a record high, credit is going down, banks are failing…what do you call an economy like that?” said Carl Weinberg, chief economist at Valhalla, N.Y.-based High Frequency Economics and an unabashed user of the ”D-word” to describe Europe’s economic situation.
There is no uniformly accepted definition of a depression, but economists generally agree that depressions last two or more years and are accompanied by a big jump in unemployment, falling credit, and a massive slump in economic output.
That’s certainly been the case for parts if not all of Europe. The Greek unemployment rate hit a once unfathomable 27.2% in January. In Spain, 26% of workers are jobless. Across the euro area as a whole, more than 19 million people are out of work while the unemployment rate stands at a record 12%.
Euro-zone GDP is widely expected to have contracted for a sixth consecutive quarter in the first three months of 2013, and forecasters are penciling in another year of modest contraction for the euro zone as a whole in 2013.
The euro-zone economy is “experiencing two shocks at once: a financial crisis and fiscal drag,” said Bill Adams, senior international economist at PNC Financial Services Group.
The 2008 financial crisis exposed fissures in the euro zone. Some countries, such as Greece, were victims of overspending. But many others, such as Ireland and Spain, saw a sound fiscal record undone by the collapse of massive property bubbles that endangered the banking system. Shackled to a shared currency, economies such as Greece have been forced to embark on painful internal devaluations in an effort to regain competitiveness.
Prolonged pain on the so-called periphery of the euro zone is now spilling into the core, with activity slowing in France and even Germany, the region’s No. 1 economy. Europe’s ugly economic picture is yet to put a significant dent in the markets, however.
Even with a setback Monday as part of a global rout that accompanied a historic gold selloff, European stocks are trading near levels last seen in 2008. The pan-European Stoxx 600 Europe index XX:SXXP +0.49% remains up more than 3% year-to-date, while Germany’s DAX index DX:DAX +0.20% has gained 0.9%. Despite brief hiccups, Spanish and Italian bond yields remain well off crisis levels that would spur worries about either country’s ability to meet borrowing needs.
And Europe is certainly not a cause for concern on Wall Street, which last week saw a string of record highs for both the S&P 500 SPX -1.43% and the Dow Jones Industrial Average DJIA -0.94% .
That strength, which has overridden shocks such as Cyprus’s bank bailout and political gridlock in Italy, owes a lot to subpar but steady economic growth in the U.S., which has seen corporations and households move much more quickly to pay down debt, said John Greenwood, chief economist at Invesco Ltd. in London.
“The big question for investors is whether other developed economies need to see comparable changes in the financial health of their major sectors, or whether the U.S. remains so dominant that it can drive the financial performance of other markets” regardless of what happens at the local level, Greenwood said in a note.
That said, the euro zone and the U.K. run the risk of becoming a “sort of sideshow, cut off from the global upswing” if they fail to repair “financially broken” sectors of their economy, according to Greenwood.
That doesn’t mean U.S. companies are immune. American exporters are feeling the pinch, something likely to act as a drag as U.S. earnings season moves into full swing. U.S. monthly exports to the European Union fell to a two-year low of $20.1 billion in February.
Ford Motor Co. -1.49% is cutting jobs and closing European plants. The company saw new passenger-car registrations tank 23.3% in the January-February period, according to industry data.
Caterpillar Inc. CAT -0.22% Chief Executive Doug Oberhelman told CNBC last month he was “very concerned” about Europe, but that the company was “doing OK.” A global slowdown in demand for mining equipment has prompted analysts to cut earnings forecasts for the world’s largest maker of mining and construction equipment.
Risk of ‘almost endless depression’
Unlike the more subjective “depression,” a recession is technically defined as a broad but temporary decline in economic activity. More loosely, an economy is often said to be in recession if it posts two consecutive quarters of contraction. There is less argument over the terminology when it comes to Greece, which has seen economic output contract by more than 20% since it kicked off the euro-zone debt crisis in late 2009.
For the overall euro zone, a look at a chart of quarterly gross domestic product or industrial production paints a bleak picture. After a steep contraction in 2008 and 2009, growth returned in 2010 and 2011, only for the economy to begin shrinking again in the first quarter of 2012. Total economic output has yet to return to its 2008 level.
Germany has largely avoided the weaker trend, but the region’s largest economy is showing signs of stagnating. Germany’s unemployment rate unexpectedly ticked up to 6.9% in March, just above a two-decade low of 6.8%.
France, the second-largest economy, has taken a turn for the worse, with purchasing-managers data pointing to a steep fall in first-quarter GDP.
For its part, the European Central Bank is sticking to its call for a euro-zone recovery to take hold in the second half of 2013, strengthening in 2014. ECB President Mario Draghi earlier this month, however, added the caveat that the forecast is subject to “downside risks.”
Meanwhile, the rescue of tiny Cyprus, which for the first time saw uninsured depositors forced to bear some of the burden of recapitalizing weak banks, could only make the situation worse.
If future bank rescues are to be funded by creditors rather than taxpayers, it implies that euro-area banks will have to be much more conservative in seeking funding, said Invesco’s Greenwood. And that means they will also be more conservative when it comes to lending.
“In view of this outcome, it is clear that the euro-area orthodoxy implies further austerity and almost endless depression,” he said in a note.
While the U.S. took controversial steps to shore up and fix its troubled lenders, Europe has moved in fits and starts.
European banks continue to scale back lending to the private sector, albeit amid weak demand for credit.
Thrifty Germans make poor customers
The poor economic performance makes it all the more difficult for the euro zone’s hardest hit countries to dig out of their fiscal holes, further feeding the region’s debt crisis.
That’s why U.S. Treasury Secretary Jacob Lew used a trip to Berlin to hint that Germany and other euro-zone countries with solid finances and trade surpluses should move to increase spending and boost consumption.
It won’t happen. Germany earlier this year approved a draft budget that aims to cut spending in 2014 and German Finance Minister Wolfgang Schäuble rejected any implied criticism of the country’s budget plans.
Calm has largely prevailed in financial markets since late last summer, when Draghi famously pledged that the ECB would do “whatever it takes” within its mandate to save the euro. That was followed by the creation of a bond-buying program, known as OMT, for outright monetary transactions, that could step in to buy the debt of governments that apply for help from Europe’s rescue fund.
So far, confidence seems to be holding, though doubts over the ECB’s ability to roll out the program if needed have started to emerge in the wake of Italy’s inconclusive February elections and ensuing political gridlock.
Without a strong government capable of signing off on conditions that would accompany the launch of the OMT program, the ECB may find itself unable to step in if Italian borrowing costs soar back to levels that threaten to shut the euro zone’s third largest economy out of the credit markets.
Some economists fear that the ECB may be running out of other options, echoing the inaction seen on the fiscal front. If so, it’s hard to see how the economy moves into recovery mode, they say. “If you’ve got a problem and you can’t do anything about it, it gets worse,” Weinberg said.
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