Diving Into the Latest Eurozone GDPs

Investor sentiment can be hard to pin down. There is no concrete measure, no survey or composite index giving a firm read. Researchers try, but they mostly capture how people feel in a given moment, which can have a host of outside influences. So it helps to use qualitative tools, too. Here is one: When economic news is mixed, do headlines emphasize the good parts or the bad parts? Lately, in US economic news, the good bits have started getting a teensy bit more play than they did earlier in this bull market. But when it comes to Europe, the negative still dominates, suggesting sentiment is overall still quite skeptical. Headline reactions to today’s eurozone GDP data are the latest example, in our view.

Aggregate eurozone GDP grew in Q2, advancing 0.3% q/q.^[i] That repeated Q1’s growth rate and beat expectations for 0.2%—and extended the modest resurgence from a very meh 2023. Seven of the 10 member states reporting thus far notched growth, including three of the four biggest: Spain (0.8%), France (0.3%) and Italy (0.2%).^[ii] But headlines zeroed in on the big country that didn’t grow: Germany, whose GDP fell -0.1% q/q, thus extending fears that the eurozone’s biggest economy is flirting with recession and doomed to be the bloc’s proverbial sick man.^[iii]

Perhaps, but for stocks, much of the discussion is ancillary. There is a lot of handwringing about Germany’s makeup and its relatively larger reliance on heavy industry—particularly the auto industry. This is the root of all the weak long-term forecasts, which warn it risks getting hollowed out by subsidized international competition and the government’s lack of a big public-investment industrial strategy. But these are all long-term structural topics and well-known. They also aren’t even necessarily right, given Germany’s private sector drives the bulk of the country’s investment and its services sector does a lot more of the heavy lifting than people think.

For stocks, the issue is much simpler: Did we learn anything new and negative about Germany’s economy today that we didn’t already know? We don’t think so. The relative weakness goes back a few years: German GDP has alternated quarterly between growth and contraction since Q4 2021. So using the common definition of recession—two consecutive quarterly GDP declines—Germany has been “on the brink of recession” for two and a half years. Higher energy prices—and their effect on the chemical industry—are old news. So are auto industry struggles, including faltering demand for electric vehicles (EVs) and China’s subsidized export push. Judging from the German auto industry’s returns relative to broader German stocks, markets are well aware.

Then, too, think about what the GDP report actually said. Germany’s preliminary estimate doesn’t include a detailed breakdown. But the Federal Statistical Agency’s accompanying commentary noted the decline stemmed from falling investment in construction and equipment. Those categories are narrow and hardly indicate broad economic weakness. They say nothing about services, which is over 60% of German GDP.^[iv] They say nothing about consumer spending, which is the vast majority of activity at an expenditure level. S&P Global’s services purchasing managers’ index (PMI) speaks to that, and it has exceeded 50—implying growth—since March.^[v] That factoid didn’t get much attention today, which we think points to a big gap between sentiment and reality.

So no, we don’t think Germany’s economy is firing on all cylinders. But it does appear to be better than meets the eye, and the negatives are well-known. Stocks move most on surprise, and with the bad news all seemingly baked in, the good kind of surprise is higher-probability. And with expectations so meager, it shouldn’t take much for reality to keep delivering that positive surprise to global stocks.