Europe: A Glass Half-empty or Half-full?
Earlier this month, information services company Markit published its latest eurozone composite purchasing managers’ index (PMI) for the month of April. The firm reported that eurozone economic growth began the second quarter of 2014 at a three-year high, as output expanded across Ireland, Spain, Germany and Italy. The combined output of the manufacturing and service sectors rose at the fastest pace in almost three years during April. Markit said the outlook was also positive as new orders and backlogs of work rose further.
Reflecting the improvement, the PMI reached 54.0 last month from 53.1 in March. Any reading over 50 indicates an expansion in economic activity; this was the tenth successive month in which the PMI was recorded above 50 and was the highest level since May 2011. Growth was led by the manufacturing sector, with goods production showing its steepest gain since January.
Employment rates were also higher although the rate of expansion was described as modest. Ireland, Spain and Germany recorded increases in payroll numbers, with rates of job growth hitting a near eight-year high in Ireland and a two-month peak in Germany. However, levels of employment continued to fall in France and Italy.
“The upturn is led by Germany, while France continues to lag with the French PMI merely indicating near stagnant growth,” said Chris Williamson, chief economist at Markit. “Strong upturns are becoming apparent in Spain and Ireland, where the rates of growth rose to the fastest for seven and eight years respectively.”
Not everyone is as positive about the PMI data. Unemployment rates in many EU member states indicate the weakness of the recovery – in Spain, for example, the youth unemployment rate was 57.7% in November 2013. Additionally, some question the quality of the jobs held with ‘zero-hours contracts’ – basically jobs that do not guarantee any set number of hours for the employee – which, for example, are used by a number of UK employers.
John Greenwood, chief economist at fund manager Invesco says that other symptoms of weak domestic demand in the eurozone include the swing to a substantial current account surplus of 2.2% of gross domestic product (GDP) over the past two years, which largely reflects the region’s weak imports, static exports and very low inflation rate of below 1%.
Because European governments are not utilising policy tools such as faster money and credit growth, fiscal stimulus or currency devaluation, the prospects for further improvement for 2013 and 2014 rest primarily on better export data, he says. “But partly due to the stagnation in Europe and the weakness of key emerging economies such as Brazil, India and China, the upswing in world trade is not occurring.” As a result, real GDP growth in Europe for the year ahead is likely to reach just 1%.
Dr. Steve Davies, education director at the London-based free market think tank the Institute of Economic Affairs (IEA), says there is still a question of the overall economic condition of the eurozone, given politicians’ reaction to the crisis since 2009. “There is some deflation in the eurozone that affects all of the countries, including Germany, where growth has been export-led, much of it to other eurozone countries that are in deep recession.” Recovery in Europe is dependent on a revival of growth in the world economy.
“An important caveat is that the euro is out of intensive care, but it is still shaky. The structural problems in the eurozone have not been dealt with and any unexpected crisis could revive the problems,” he adds.
Because it is difficult to predict what might happen, corporate purchasing managers remain cautious. However, Davies believes there are opportunities as some assets, particularly in countries such as Spain and Ireland, are undervalued and represent an opportunity.
Merger and Acquisition Activity
Michael Cole-Fontayn, chairman for Europe, the Middle East and Africa (EMEA) at BNY Mellon, says there has been a healthy pick up of the performance of financial assets in some of Europe’s economies. The current takeover bid for Anglo-Swedish pharmaceutical company AstraZeneca by US-based Pfizer indicates that the acquirer believes the assets are available at fair value. Pfizer may also be prepared to place a premium on the offer to quell political opposition to the move.
“Increasingly, management teams and boards of directors are prepared to rake a risk on some fairly significant cross-border merger and acquisition (M&A) activity where there is a strong industrial logic behind it, as well as financial logic,” says Cole-Fontayn.
Davies says it is difficult to predict where the next wave of M&A activity will take place. To a large extent, the recent flurry in the pharmaceutical sector is driven by a maturity of the market. “It is becoming more and more difficult to produce drugs that will have a major impact – the era of miracle drugs is at an end,” he says. “Growth will be incremental and rates of return in this sector are stagnating. M&As in this sector will be defensive moves.”
According to the ‘2014 M&A Outlook Survey’ published by KPMG, deal activity will be solid during 2014, with 29% of global activity taking place in Western Europe and 5% in Eastern Europe (excluding Russia). The main driver of M&A activity will be large cash reserves or commitments, cited by 25% of those surveyed by KPMG.
A corporate development officer at a diversified industrial company told KPMG that he was planning for an increase in M&A because of the existence of “better economic conditions and less uncertainty”. Phil Isom, principal and US head of corporate finance and restructuring at KPMG says: “The European debt crisis is creating many opportunities.”
An Uneven Picture
Bank funding for small to medium-sized enterprises (SMEs) in particular has been a problem for companies in Europe during the downturn. However, the fortunes of SMEs vary across the region from country to country. Germany, for example, has a strong SME sector, with companies renowned for their strong governance and economic management. These rely strongly on their core house banks, which have provided sustained and quality credit during the downturn.
“There are structural reasons that Germany’s SMEs do so well,” says Davies. “There is good access to finance and the education system supplies highly skilled employees.” SMEs in peripheral eurozone countries have fared less well, with funding proving to be a challenge due to perceptions that SMEs are poorly managed and have problems attracting suitably skilled employees.
One of the UK’s ‘big four’ banks, Royal Bank of Scotland (RBS) came under fire at the end of last year for its lending practices to small businesses. The bank was alleged to have caused healthy businesses to fail for its own gain, as it then snapped up the assets at a low cost.
On a more positive note, Cole-Fontayn believes that moves towards a European single supervisory mechanism for systemically important banks is helping to revive asset-backed securitisation. The concept of safe securitisation is consistent with encouraging greater flexibility for banks to manage their balance sheets. This would bring more capital into the markets in Europe, which, in turn will finance growth. However a challenge will be this month’s European elections, which will lead to a pause in policy making. At present euro-sceptic parties are expected to make considerable gains in the elections, which will change the make up of the European Council and of the European Commission.
Earlier this year the European Economists for an Alternative Economic Policy in Europe, a network of European economists who promote full employment, issued a memorandum on policies in the European Union (EU). It argued that while the region was set to exit from recession, parts of Europe are beset with depression-like conditions; unemployment is exceptionally high in the peripheral eurozone countries and not expected to decline appreciably in the near future.
“Harsh austerity policies have led to a widening social polarisation in Europe and to a process of industrial restructuring in which the position of Germany and other Northern countries has been strengthened while productive capacity in Southern Europe is being weakened,” the memorandum stated.
“The crisis has also led to a significant shift in the distribution of income. In most countries outside the euro area core real wages have declined, and strongly so in the euro area periphery and much of Eastern Europe. At the same time the hierarchy between member states has been attenuated with the position of Germany and other Northern states being strengthened, while the position of Southern states has been weakened and wide areas of economic policy effectively dictated by Brussels.”
Davies points out that Europe still has significant “internal headwinds”, including an ageing population and the “very considerable promises made to pensioners by governments”. This could lead Europe into a period of prolonged stagnation, similar to that experience by Japan since the late 1980s. Exports to countries outside Europe such as those in Asia and Africa and to Russia will be vital to growth. German motor giant BMW, for example, now exports the bulk of its vehicles to Russia and Africa. These non-European markets require goods with high value-add, such as sophisticated machine tools, technical skills and services.
The European alternative economists group’s memorandum recommends a Europe-wide industrial policy should be established that is more long-term in nature. It suggests a number of areas of focus including: