SUMMARY
Europe’s equity rally has stalled this year. One factor that may help boost the region’s shares is increased fiscal spending in China, say Guillaume Menuet and Judiyah Amirthanathar,
Europe is a relatively open and large economy – Europe’s openness, with exports of goods and services representing more than 50% of its GDP, can be a curse (blessing) when global economic activity is decelerating (accelerating) markedly. Geographical proximity matters when trading goods and services, and geopolitics might also become more important parameter.
Upside surprises in the US versus downward surprises in China – European exports to the US have been outpacing those to China comfortably since the second half of 2020, both because of US economic strength but also due to the rolling China lockdowns.
Yet, China still matters more for Germany – Short of a substantial rebound in key segments of the Chinese economy, German manufacturing confidence will likely struggle to recover, perhaps extending recession in Europe’s largest economy.
Europe should improve, but more likely to be a 2H-2024 story – A stronger-than-expected start to 2023 means that we are adding 0.1-percentage-point (pp) to 0.7% for euro area GDP and worth 0.2pp to 0.5% for United Kingdom (UK) GDP. While we do not anticipate a recession in 2024, we lower our GDP forecasts by 0.5pp to 0.6% for the euro area and by 0.3pp to 0.8% for the UK. Disinflation the dominant trend, allowing central banks to pause? – In the absence of a sustained decline in inflation in 1H-24, it is difficult to envisage a scenario in which policy rates can be lowered in either the euro area or the UK before the second half of 2024.
Impact of China weakness on European equities - Stoxx 600 index (which includes UK) generates 75% of its revenues from Europe and Americas. Asia Pacific contributes 20% of which China is around 6.0%. We note that European equities have much higher positive correlation to US PMIs than to China’s.
Europe equity conclusion - While the rally appears to have stalled since April 2023, reflecting in parts concerns about disappointing Chinese growth prospects, US growth outperformance has contributed to range trading. We believe that European equities have now priced in weakness in Chinese GDP growth. If China announces more positive fiscal measures to help its domestic market, we believe there would be more upside potential for European equities.
