Europe's Economic Outlook Darkens, Sends Shudder Through Markets

Five Days of Declines for European Stocks
  • Gauge of financial risk appetite falls to lowest in 2 years
  • Stocks tumble, Europe's negative-yielding bond pile swells

Hints of investor optimism in Europe were snuffed out this week, as the darkening economic outlook registered across the continent and sent stocks and credit markets sliding.

While market turmoil at the start of this year was sparked by a selloff in commodities and Chinese stocks, the reality of Europe’s own woes hit home as companies reported dismal earnings, and policy makers and institutions lined up to cut economic forecasts and warn of further risks.

The European Commission cut its prediction for 2016 growth in the 19-nation bloc to 1.7 percent from 1.8 percent and said the largest economies of Germany, France and Italy will all perform worse than predicted just three months ago. While the European Central Bank may spur into action again, moves in the euro and stocks suggest President Mario Draghi may be losing his ability to convince investors he can anesthetize the region from risks.

“Markets had a very rough start,” said Andreas Nigg, head of equity and commodity strategy at Vontobel Asset Management in Zurich. “There’s only so much central bankers, even Draghi, can do. Each incremental dose probably has a lower impact than the previous one. The weaker-than-expected economic growth and the associated increased likelihood of a recession led to selling of risky assets.”

Stocks Carnage

The blunt truth is that the euro area is still struggling to recover nearly six years after it first bailed out Greece, while European leaders are trying to tackle their latest crisis and stem the inflow of refugees.

The doom and gloom nixed a nascent stock-market recovery in Europe, with a drop of 3.6 percent in the region’s shares this week almost completely erasing the rebound from the previous two. The losses have left the Stoxx Europe 600 Index down 9.9 percent this year, its worst start since 2008. It’s trading near its lowest valuation since July relative to a gauge of global equities.

Since the start of the year, no industry group has managed to escape the carnage. Banks and automakers plunged the most, down more than 18 percent. Credit Suisse Group AG sank to its lowest price since 1992 on Thursday after posting its biggest quarterly loss in seven years. Daimler AG fell to a more than one-year low after revising down expectations for 2016 sales because of slowing demand in China.

Analysts have grown more pessimistic about the earnings outlook for Stoxx 600 companies. They’ve slashed their profit-growth projection to 3.9 percent for this year, compared with 6.7 percent at the start of December.

Losing Money

While European shares are getting battered more than stocks worldwide, most other markets aren’t faring much better. Globally, only 1 percent of equity fund managers avoided losses this year as a measure tracking volatility across asset classes surged to near its highest level since September.

“The tone is one of nervousness and uncertainty,” said Nick Matthews, head of European economic research at Nomura International Plc in London. “It’s not just a Europe story -- there’s a general questioning of the strength of the global economy.”

Amid a run of dismal earnings, the financial credit risk of European banks and insurers has risen to the highest in more than two years. The cost of insuring subordinated debt climbed for a seventh day Friday, and reached the highest since July 2013, based on the Markit iTraxx Europe Subordinated Financial Index.

Policy makers aren’t having it any easier.

Central bankers, battling low inflation and either feeble or imbalanced economies, highlighted “downside risks” to growth and laid the blame for the deteriorating outlook on external factors, including weaker oil prices, the slowdown in China and volatile markets.

Darker Skies

In London, Bank of England Governor Mark Carney said it’s an “unforgiving global environment” right now. At an event in Frankfurt, Draghi warned of “forces in the global economy today that are conspiring to hold inflation down.”

The darker skies are reflected in economic data. Citigroup Inc.’s Economic Surprise Index for the euro area dropped to its most negative reading since 2014 last week, meaning that reports have been weaker than forecast. As similar measure for the U.K. has been below zero since April of last year.

Expectations of more stimulus from the ECB have pushed the amount of government debt yielding below zero percent to more than $2.4 trillion, equating to about 38 percent of the Bloomberg Eurozone Sovereign Bond Index.

German two-year yields fell below minus 0.5 percent for the first time on Wednesday, and eight-year rates turned negative for the first time since April. As bonds climb, the meager yields are failing to attract investors at auctions. Germany didn’t reach its sales goal at the past three debt sales.

Forward contracts based on the euro overnight index average, or Eonia, are fully pricing in a 10 basis-point cut to the ECB’s deposit rate at the central bank’s March meeting, data compiled by Bloomberg show. The move in German two-year yields suggests the market is looking for an even bigger cut, according to Mark Dowding, a London-based portfolio manager at BlueBay Asset Management LLP.

And while bonds rally, gains in the euro signal that the ECB chief’s message is being drowned out. The euro climbed to a more than three-month high versus the dollar on Thursday, even after Draghi reiterated he was prepared to take action to counter global pressures pushing down inflation.

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