Renewed signs of economic weakness in Europe have spooked investors and led to a significant correction in European stocks. In particular, there has been a spate of disappointing economic releases from Germany with industrial production, exports, and business confidence all coming in below expectations. This is concerning because Germany has been the backbone of the overall recovery with better growth relative to other European countries.
There are still some bright spots, however: Bond yields across the Eurozone are low and falling, which is a much different backdrop compared to 2010 – 12 when yields in some countries were soaring due to fears of widespread defaults. Low interest rates should be helpful for consumers and business. In addition, the value of the euro has declined by nearly 10% relative to the dollar since June, which should make their export sector more competitive. Finally, and perhaps most importantly, monetary policy is becoming increasingly supportive with the European Central Bank announcing a series of new measures designed to give a boost to the recovery (including an asset purchase program that just commenced this week), with assurances that they’re prepared to do more if necessary.
Overall, while risks to the outlook have risen, we still believe that the evidence on balance suggests that the recovery should continue, although third quarter growth may have stagnated. Faster economic growth would certainly be welcome, but as was the case here in the U.S. for the past several years, slow growth combined with increasing policy support may yet be a potent combination for European risk assets.