Market Memo: Europe's on the mend


Continental Europe is on the cusp of an economic recovery. Its two biggest economies, Germany and France, helped pull the region out of the longest post-war recession on record in the second quarter, with Germany posting 2.8% annualized growth and France 2%. Overall, gross domestic product (GDP) in the 17-nation euro zone grew 1.2% in the April-June period, modestly exceeding the 0.8% consensus growth forecast.

Across the continent, the nascent signs of recovery were everywhere. France, whose economy declined the two previous quarters, saw household spending grow and companies increase exports of goods and services. Portugal expanded a surprising 4.4%, snapping two years of decline, and signs of life also were notable among its southern periphery neighbors. Spain’s economy contracted by only 0.4%, much better than the first quarter’s 2% percent drop, and unemployment, while still high, was relatively flat. Even the fragile Greek economy, which has suffered 20 consecutive quarters of decline, shrank more slowly.

It helped that the cost of borrowing for companies based in the euro-zone’s southern tier has started to decline, providing cheaper cash for Spanish and Italian companies. The European Central Bank (ECB) in July further helped to breathe more life into the region by committing to keeping its interest rates at record lows for an “extended period”—policy language with which followers of the Federal Reserve Bank are intimately familiar. The ECB’s main rate now stands at a record low 0.50%, and the ECB this month reaffirmed its “extended period” stance.

European equities should benefit
All this encouraging economic news should translate into increasing demand for European equities and, we believe, higher stock valuations—particularly among those companies with outstanding managements, strong balance sheets and significant market share. One sector that stands out is European financials. Many of the continent’s financial institutions are now trading at or below book value and offer strong and sustainable dividend yields. European banks and insurers spent the past few years restructuring their balance sheets by shedding assets and noncritical businesses, and by heavily provisioning against nonperforming loans. These companies have also shrunk payrolls by the thousands and, in the process, incurred billions of euros in cost savings. Especially attractive are financial firms in Switzerland, France and Italy.

Another European sector that is attractive at this juncture is services. Recruitment companies offering both temporary and permanent employees tell us they are experiencing rising demand for their services as an improving euro economy translates into the need for more workers. This is what happens when recession gives way to growth—companies actually start to hire again. This is a welcome occurrence on a continent where many of the euro-zone’s periphery countries remain indebted.

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.
International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.
Federated Global Investment Management Corp.
Copyright © 2014 Federated Investors, Inc.

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