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By HaleStewart April 2, 2014 9:21 am
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Is It Time To Become Optimistic About the EU?

The EU is an economic and investing conundrum right now.  Unemployment is still very high; while it appears to be cresting, there is little indicating we're seeing a meaningful reduction in this key metric.  Employment is still very weak and loan growth is still negative.  However, recent PMI surveys along with industrial production numbers, a strong trade surplus and  the ECB's pledge to do "whatever it takes" to bolster the euro have led investors to bid the euro and various equity markets higher.  

First, let's start with the bad.


Unemployment has been very high for over a year.  While this is a lagging economic indicator, it is still obviously very concerning. 

More importantly, the rate of unemployment has been increasing for the duration of the post recession expansion, indicating the problem has been getting worse, not better.

Furthermore, the coindicent indicator of employed persons is still declining and has been since the start of the recovery.  This further bolsters the argument that the underlying ecoomic fundamentals are not in good shape.

And the pace of credit expansion has been declining for the last two years.

On the positive side, several indicators have been showing signs of a nascent expansion.

Sentiment indicators have been rising -- some (top two charts) more recently while others (ZEW survey) for a longer period.  This rise in sentiment is partly behind the rise in the euro and various EU equity markets, as it indicates investors are more willing to commit risk capital to the market.

Manufacturing sentiment has also been rising, printing numbers above the 50 line (which indicates the industrial sector is expanding) for the last three quarters.  This is starting to translate into meaningful industrial production numbers:

The year over year percentage change in industrial production has turned positive in the last five readings.

Perhaps most important is the current account to GDP reading, which printed a very strong 1.5% in 2013.  This is probably a big reason for the euro's strong showing verses the dollar over the last 6 months.

The potential final piece in the expansion puzzle is the possibility of ECB action to slow the deflationary trend occurring in the economy.  While recent public announcements from Germany indicate support for such a plan, the ECB has yet to pull the trigger.

As of now, the indications are of an expansion that is very much at the beginning, and, therefore, could easily become undone. While the surge in the current account is encouraging, should the EU economy start to meaningfully grow a surge of imports would follow, thereby depressing that positive metric.  In this scenario, other economic numbers would have to pick up the slack, meaning we'd need to see continued improvements in manufacturing and other sectors.  And the verdict is still out on whether there is enough underlying momentum for that to occur. 

While the recent news is encouraging, it's still very recent and in need of further traction before we declare victory.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer


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