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Is Europe Really Recovering?


Data that is "less bad" is being heralded as a sign of a bottom or nascent recovery, but just because something is declining at a slower rate doesn't mean there is improvement.

"Europe is getting better."

I keep hearing this on TV and just shake my head. I often wonder whether or not the person speaking those words has actually traveled there to see what's really going on. I believe it's quite safe to say that many of them have not.

The photo below is a prime example. On July 25, CNBC was discussing this very subject and used the graphic below as evidence that Europe is "bottoming."

Just a few days ago we did see better-than-expected PMI data for the eurozone, but let's take a look at each point quickly:

"UK: Q2 GDP Up 0.6%"

Excuse my cynicism, but since when has 0.6% been considered a good number? Everything is relative I suppose, and this is their best number since early 2011
. However, as this chart from the the London Telegraph shows, GDP has been in gradual decline for nearly a decade.

Click to enlarge

"German and Dutch Confidence Is Higher"

Again, this may be cynical, but this data is dependent on
the "emotions" of people and not necessarily based on any hard data. Maybe the weather was nice that day and everyone was happy? One can see from the chart below that confidence is, in fact, quite high in Germany, but it's been there all year, so why is now any different? It seems to me that CNBC is cherry-picking what little "positive" data there is.

But wait. Perhaps you noticed what just happened there. Consumer confidence was not the data point that was released. It was German Ifo Business confidence.

As you can see from Ifo's own data, this data has been trending down for the last few years as well.

CNBC actually proves my point because their final two data points aren't "green shoots" at all. Yes, Spanish jobless claims fell, but it fell to 26.20% from 27.16% in the previous quarter. Any improvement is good, but let's cobble together more than one month before we start calling for a change in trend. Anyone that pays attention to employment data points knows that there is a myriad of ways to manipulate the data. The media is so desperate to put a good face on what's happening that they often intentionally misrepresent data to make it sound better than it is.

France is not only a problem, but it very well may be the "pale horse" of the continent. In my opinion, people are wildly underestimating the problems that will come from France. Now we see that French jobless claims are hitting record levels. Almost 3.3 million French are out of work, and this is indicative of the vast majority of Europe. I'll circle back around to France in a bit.

To be sure, there are some pockets in and around Europe that aren't doing poorly, but like any puzzle, we must step back to see the full picture. What strikes me as interesting is how any piece of data that is "less bad" is immediately heralded as the sign of a bottom or nascent recovery. Just because something is declining at a slower rate doesn't mean there is improvement. It likely means that it's difficult for things to get much worse without some exogenous event. Based on the data I'm about to present, I believe that things in Europe are actually worse than they've ever been.

Beginning with the PIIGS, Greek GDP is expected to contract by 7% by year's end. Industrial output is down 4.6% year-over-year and the little manufacturing they have was also down 1.8%. Lending to business continues to fall, deposits are still leaving banks, and unemployment is a stifling 27.6% up almost 1% from last month (under 25, it's over 55%). Almost 1.4 million Greeks are out of work.

The IMF has handed down a -1.8% forecast for Italian GDP, which is now down ~10% since 2007. PMI's are still in contraction. Manufacturing in June ticked higher, but services fell and both are below 50, unemployment is over 12% (great, compared to the rest of the periphery). Its debt has ballooned to 130% of GDP in the last year (up 650bps from 2012), the YTD deficit is now 7.3% from just 2.9% in 2012, and S&P downgraded their sovereigns to one notch above junk, saying that Italy needs to run a surplus equal to 5% of GDP just to stabilize the debt ratio.

Are you seeing a recovery yet? I'm not either, even though consumer confidence for July came in at 97.3, better than the expected 95.5 and 95.8 from June, and July manufacturing PMI came in at 50.4 from 49.1 in June. Q2 GDP just came in at -0.2% QoQ and -2.2% YoY.

Let's keep going.

Portugal's GDP forecast is -3%, their deficits continue to widen, and total debt to GDP sits at a staggering 370%. Public debt is nearing 130%, up 1500bps year-over-year. There is no coming back from numbers like that. This makes no mention of the fact that Portugal also has to raise 23% of GDP in new funding for this year, and 22% for next year. From where will that money come?

Spain still faces near record unemployment at 26.2% as of the last report, with youth unemployment double that. Public debt is expected to surpass 100% of GDP in 2014. Housing transactions were down 3.7% in May year-over-year and mortgages were even worse -- down 29% year-over-year. Perhaps the most frightening fact is that a massive corruption scandal has recently exploded in the highest ranks of political office, adding unneeded fuel to the social-uprising fire.

Even Ireland is now struggling again after showing signs of life. GDP is down in four of the last five quarters, the budget deficit for 2014 has exploded to exceed 7% of GDP, and unemployment is still in the low teens.

According to EuroStat, Euro area (EA17) sovereign debt as of Q1 2013 is now an astounding 92.2% of GDP. That figure is up 400bps year-over-year, nearly 5%. There is not one single economy in the continent I can find that is growing at that rate. The IMF is forecasting
a second consecutive annual contraction of 0.6% for the eurozone in 2013. Is it not obvious by now that, contrary to Keynesian thought, debt is a burdensome obstacle preventing these countries from even attempting a recovery? In their latest quarterly report, Lacy Hunt and Van Hoisington make this very point:
Astronomical sums of money have been expended by both monetary and fiscal authorities since the crisis. With the benefit of hindsight it is clear their efforts have not aided economic growth, but rather the balance of their actions has been counterproductive. The Fed has maintained the Fed Funds rate at near-zero levels, and it has tried to lower longer term rates through a series of quantitative easings. The effect of each of the quantitative easings was the opposite of the Fed's intentions.

That comment was specifically directed toward interest rates, but it all serves the same purpose as the Fed implemented these policies to stimulate aggregate spending and create a favorable environment for companies to hire new people. All that has happened with these policies, both in the US and in Europe, is that equity markets have caught fire, enriching a portion of the population but widening the wealth gap more than anything. Hunt and Hoisington say that the "recovery" has passed most people by:

Based on the standard of living, as measured by the real median household income, this entire recovery has bypassed the consumer sector. The standard of living has contracted regularly in recessions, but this is the first time deep into an expansion that it has continued to erode. The current standard of living is unchanged from 1995 (see the chart below).

Granted this is supposed to be about Europe and not the USA, but if this is what is happening here, what in the world do you think is happening there?

Germany continues to be the glue that holds the continent together, but recently we've seen weakness in its data as well. In early July, German factory orders for June fell 1.3% month-over-month and 2.0% year-over-year versus expectations of an increase of 1.2% and 0.1% respectively. Data was negative for May as well. A few days later we learned that exports fell 2.4% when expectations were for an increase of 0.1% and +1.7% in the prior month. Granted, Manufacturing PMI for July was a bit higher along with Factory Orders, but Services PMI was down again. The good news is that inflation is almost nonexistent. That is good news isn't it? Overall, one habit people must break themselves of is extrapolating German data to the rest of the eurozone. Clearly, Germany is not indicative of the eurozone.

Getting back to France, attitudes are at their worst levels in years.

Of course, that coincides with their record unemployment and strong dissatisfaction with the current leadership, which has failed in every avenue since taking over from Nicolas Sarkozy a few years ago. 2013 will see a deficit of ~4%, greater than the expectation of 3.7%. I haven't even mentioned the ever-increasing social unrest developing between Christian and Muslim groups (in the UK as well). Before Europe finds final resolution, I believe the social unrest between Christians and Muslims and between citizens and their governments will fester and become a serious problem across the continent. This could be the exogenous event I mentioned earlier.

Across the continent, the ECB came out on August 8 and cut the eurozone's GDP forecast to -0.6% from -0.4%.

Finally, we circle back to the beginning of all of this back in 2008…financials.

Many eurozone banks are following the poor example set by the Japanese. Their balance sheets are filled with low quality loans/ assets and many simply cannot take write-downs needed due to the recapitalization requirements that will follow. These banks know it will be very difficult to raise that capital…if they can at all.

YoY growth in loans to eurozone households (source: ECB)

YoY growth in loans to eurozone non-financial companies (source: ECB)

I do believe that many observers make the mistake of believing that weak banks are the primary agent limiting growth in Europe. While that makes sense from an economic textbook point of view, it is putting the cart before the horse. Excessive government regulation and rampant corruption continent-wide are the real culprits, and only with a sea change of ideology will Europe have a chance at survival. This is the core problem that most financial observers simply cannot grasp.
Twitter: @axiosadvisors

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