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Gloomy Math Will Weigh On Europe – Investopedia

[OPINION: The views expressed by Investopedia columnists are those of the author and do not necessarily reflect the views of the website.]

My team of research analysts believes trouble is brewing beneath the surface of European equity markets. Our analysis indicates that weakening demographic trends in Europe will suppress the region’s economic growth for the foreseeable future. In other words, we believe investors should avoid owning European equities.

We made the call on #EuropeSlowing back in April, just as the continent’s stock markets started rolling over. From their year-to-date highs, France’s CAC 40, Spain’s IBEX and the German DAX are down -4.3%, -7.9% and -3.3% respectively. In contrast, over the past three months the Nasdaq is up 4.3%, while the S&P 500 is up 2.5%.

Our proprietary Growth, Inflation, Policy (GIP) model is signaling deceleration in both economic growth and inflation across the broader Eurozone economy. This view runs counter to Wall Street consensus, which we believe is largely complacent on the long side of both the Euro currency and European equities.

Actively tracking demographic trends is an essential tool for getting big macro moves right. Consumption is a major driver for developed economies. Likewise, if the age group of peak spenders is shrinking, you’ve got a problem on your hands. In the U.S., consumption makes up approximately 70% of GDP. Across the European Union, that figure is about 56%. The setup in the U.S. and European equities could not be more different.

When you consider how important consumption is to both the U.S. and Europe, the following recent data is disconcerting:

  1. Swiss GDP came in at 0.3% in Q2 of 2017 is the lowest rate of change since 2009
  2. Italian Retail Sales came in at 0.00% y/y (those are zeroes) in July vs. +1.5% in June
  3. France’s Retail PMI dropped down to test “contraction” zone at 50.4 in August vs. 54.1 in July

In other words, Eurozone consumption may be peaking.

In contrast, US Retail Sales accelerated in July to +4.2% year-over-year growth. Meanwhile, our US GDP tracker continues to tick higher on both a sequential and year-over-year basis as a result of the aggregate data that has been reported.

Within European equities, we think downshifting at the sector and style factor levels is appropriate. What this effectively means is being short of Spain (EWP) and Italy (EWI), which boast elevated exposures to the Financials sector at 42% and 35%, respectively.

Why?

If European growth is slowing, expect the Financials sector to get hit as bond yields fall, cutting into their profitability. (Banks profit off of the spread between short-term and long-term rates by borrowing short and lending long.)

Getting back to demographics, In most developed nations, the age bracket of peak consumers are 35-54 year olds. Simply put, if this key demographic subset is slowing, it’s cause for concern. That’s precisely what’s happening in Europe, particularly in the south of Europe.

In Spain, Portugal, Greece and Italy this peak spending demographic is set to decelerate through 2030. More specifically, the estimated growth rates in this peak spending cohort by 2030 for these four economies are -2.5%, -2.3%, -1.8%, and -1.6% year-over-year, respectively.

That’s bad news.

For the Eurozone as a whole, the growth rate of 35-54 year olds by 2030 will be an estimated -0.7% year-over-year. This compares to +1.0% year-over-year in the U.S., thanks to a lift from “Millennials” who have now officially surpassed “Baby Boomers” as the nation’s largest living generation.

It gets worse.

As Southern Europe experiences the largest declines in their peak spending cohort, they will simultaneously have the highest Old-Age Dependency Ratios, which measures the 65+ year old population as a percentage of the total population. The old age dependency population in Spain, Portugal, and Italy is roughly 21%, 24%, and 24%, respectively. For context, this 65+ population is 18% in the U.S.

As you can see in the chart below, Europe has the combined problem of aging at a more rapid rate over the coming five years, at the same time as overall population growth slows. It’s not exactly a recipe for success. Countries appearing furthest toward the bottom right-hand side of the graph are the most troubled. Unsurprisingly, joining Europe down there is Japan.

In short, demographic trends (secular) and slowing economic data (cyclical) do not bode well for Europe. Add this to the list of reasons why we think European Central Bank (ECB) head Mario Draghi will be the world’s most dovish central banker by the end of next year. The coming demographic cliff is a gloomy mathematical reality that will hang over Europe for some time.

Hedgeye is an independent, conflict-free investment research and online financial media company. Click here to get a free month of Hedgeye’s newly-launched ETF product “ETF Pro.” It distills Hedgeye’s investment research down to tactical macro ETF exposures.

Gloomy Math Will Weigh On Europe – Investopedia

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