Riots in the streets of France over jobs laws; a near stalemate in Italy’s general election; Germany forced into a grand coalition – and still no EU constitution. Eurozone politicians seem to be doing their damnedest to ensure that the world’s largest trading bloc cannot function.
Fortunately, what the politicians do seems to make little real difference. Eurozone equity markets are now at an all-time high in dollar terms. And they are outperforming those of the US in local currency and dollar terms.
Since the recession of 2001, growth in the core of Europe has been led by exports and investment. Now domestic demand, particularly consumer demand, is starting to show the way.
There are two big reasons why the eurozone economy is starting to work. Its households are asset-rich while corporate Europe is profitable and cash-rich with the firepower to invest.
Household wealth is equivalent to that in the US, at around 500% of personal disposable income. But there are important differences in the composition and thus the volatility of that wealth. Both regions have increased the share of real estate in their wealth portfolios since the stock market bust in 2000, but the eurozone’s remains much bigger.
And its households continue to hold a much larger proportion of their wealth in bank deposits than in the US or the UK. Moreover, investments made through institutional funds are much lower. As a result, eurozone households have more stable balance sheets that should protect them better from any downturn in the global housing market or equity sell-off.
Despite recent rapid expansion, mortgage debt remains at just 60% of household disposable income, compared with 90% in the US and 120% in the UK. The burden of household finances remains lower in the eurozone than in the US. So even if the continental European property market should go the same way as that of the UK last year and the US this year, the hit on household spending will be much less than in America.
Narrower mortgage exposure
Eurozone housing debt is much more concentrated among wealthier households than it is in the US or UK. Only one in four Eurozone households have a mortgage, compared with almost one in two in the US or the UK. And while 60% of high-income households have mortgages, less than 30% of low-income ones do. So housing debt is less than 20% of gross real estate wealth compared with 44% in the US.
| Household savings as percentage of disposable income |
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| Source: Datastream |
Ironically, as eurozone households have so much of their assets in bank deposits, rising savings, interest and mortgage rates prompted by European Central Bank interest rate rises will actually increase net income receipts.
The US consumer has been spending his wealth for some time but the eurozone consumer has hardly begun to do this. Household savings rates in the eurozone are still high (and stable), while savings rates in the US are at rock bottom. So European consumers have plenty of firepower available to spend more, as and when confidence returns.
And there are signs that it is starting to do so. The German IFO business confidence survey is at a peak and the ZEW investor confidence survey has followed it up. Eurozone purchasing manager indicators show the same story.
There is a close correlation between all these surveys and industrial production growth. Indeed, the core of Europe is following its traditional economic cycle. First, economic recovery is export-led, accompanied by corporate Europe restructuring and reducing labour costs to restore profitability.
In this cycle, eurozone companies have cut back staff and switched production to the east. Rising corporate investment then boosts corporate profitability. The final stage is the return of the consumer to spending ways. All the retail and consumer surveys have been moving up, and they are reasonably good guides to future consumer spending. Bank lending to the private sector (corporate investment and mortgages to households) is another indicator of a pick-up in household spending.
Sure, the politicians remain a problem. The big three eurozone governments are all running budget deficits well above Maastricht guidelines and ignoring European Commission strictures. At the same time, politicians continue to fan the flames of so-called economic patriotism by blocking cross-border mergers. This is in flagrant breach of the Treaty of Rome and subsequent deregulation orders from the EC.
None of this looks propitious for growth and investment. However, Europe’s politicians are not running the economy. The corporate sector is getting on with the job. It is profitable and innovative, and it is exporting. When the consumer enters the fray, investors will benefit, regardless of the political obstacles.
David Roche is president of Independent Strategy Ltd, a London-based research firm.www.instrategy.com