Eurozone optimism returns as Italian crisis fades

Now that Italy appears to have settled down again, at least for the moment, we can look afresh at European stock markets.

Chris Beauchamp ChrisB_IG
Chief Market Analyst, London

Publication date : 2018-06-04T11:27:00+0100

Source: Bloomberg

It looked like we were about to be treated to a revival of the eurozone crisis, thanks to an apparent constitutional upheaval in Rome. It was as if a TV series had suddenly been recommissioned for viewers. Thankfully, the crisis appears to have passed. Yes, Italy now has a government that is not exactly a fan of Brussels or the eurozone, but a recent poll shows that Italians are still 70% in favour of staying in the eurozone. Yet again reports of the single currency’s demise have been greatly exaggerated.

A look at the current state of the eurozone economy should help provide us with a better overview of the outlook for this part of the global economy and for eurozone stock markets. Starting with the unemployment rate, we can see that, despite a brief bounce two months ago, the steady decline from the 2013 highs around 12% remains intact:

Consumer spending is at a record high as well, moving above €1.4 trillion last year and continuing to gain since then. While the stock market is not the economy, as the saying goes, if consumers continue to increase their spending there is hope for further economic growth, which should support valuations:

Many have pointed to the recent downturn in data such as gross domestic product (GDP) and purchasing managers indexes (PMIs), as if the eurozone is on the cusp of a major recession. A quick look at the composite PMI from Eurostat should calm their fears. Yes, it has fallen back from a January peak, but it is still firmly in expansion territory, and has been for four years now:

What has begun to change is the positioning in the euro. Net long positions in the currency had reached record levels in January. The downturn in data has seen some traders reduce their exposure to the euro, selling their holdings. More could follow if data fails to recover in a meaningful fashion, and if the European Central Bank (ECB) fails to hint at a hawkish shift in policy. This could be an earlier end to quantitative easing (QE) than expected, or a possible earlier than forecast increase in interest rates. A falling currency helps to boost the attractiveness of stocks, reversing the 2017 situation, when a rising euro meant that European stocks lagged far behind their American counterparts.

Despite its underperformance against the US over the past year, the DAX index remains a popular market with IG clients. It hit near twelve-month lows at the beginning of January, but a staunch defence of the 11,700 area over the February-April period allowed the market to find a bottom. A rally to 13,000 and higher followed, and while it then retraced sharply to 12,500 thanks to the Italian worries mentioned above, it created a new higher low and maintained the bullish outlook. The next step for the bulls is to retake 13,000, then post a daily close above the May high of 13,208, allowing the index to target the all-time high at 13,601.

Eurozone optimism returns as Italian crisis fades

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