Europe: Weaker Economy But Stocks Look Okay

European stocks surged during the summer, narrowing their wide gap with US equities after years of underperformance. But since autumn began, US stocks have retaken the lead.

This could be because the glimmers of hope that accompanied the euro zone’s economic improvement in the second quarter were dissipating with the renewed weakness in the third quarter.

But don’t count Europe’s stocks out, despite the feeble economy.

The overall economy of the 17-nation euro-currency bloc grew just 0.1 percent in the third quarter, or a 0.4 percent annual rate, from the second quarter, said Eurostat, the European Union’s statistical agency this week.

After the second-quarter results, there was some optimism that a sustainable recovery was starting after six straight quarters of contraction and five years of stagnation.

The overall European Union, made up of 28 countries, grew 0.2 percent from the second quarter (1 percent annualized) to the third, Eurostat said.

Other leading economies are doing considerably better. The US grew at an annualized 2.8 percent rate in the third quarter, although that number seems to have been boosted artificially by inventory buildups. Japan has reported 1.9 percent growth. China, the world’s fastest-growing major economy, said it expanded at a robust 7.8 percent rate in the third quarter.

In Germany, Europe’s biggest economy by far, quarterly growth slowed to 0.3 percent (1.2 percent annualized) from Q2′s 0.7 percent (2.8 percent), primarily because of flat growth of exports. Increased consumer spending was the major plus.

France’s economy, the region’s second largest, contracted 0.1 percent in the third quarter, down from 0.5 percent growth for the previous three months. Italy’s economy also shrank 0.1 percent, its ninth consecutive quarterly contraction. Germany, France and Italy together acc! ount for two-thirds of euro zone gross domestic product.

There was some good news. The economies of Spain and the Netherlands, the fourth and fifth-largest euro zone economies, inched ahead 0.1 percent, at least temporarily breaking their losing streak. And EU member Great Britain saw robust 0.8 percent quarterly growth.

As we advised in September, Europe’s “very gradual economic improvement would still be inadequate to reduce the euro zone’s main  problems, led by a record-high unemployment rate of 12.1 percent, hefty government debt, and uncompetitive labor costs, benefits and taxes.”

While the euro zone is growing slightly, unemployment, wages and inflation are all under significant pressure. The jobless rate now is at a peak of 12.2 percent. Annual inflation dropped to 0.7 percent in October, far below the European Central Bank’s target of almost 2 percent. In Ireland, Greece and Spain, inflation rates are at zero or lower.

No wonder the ECB last week made a surprise interest-rate cut, reducing its key lending rate to 0.25 percent, a record low. The ECB could take additional stimulus steps if  necessary, including private-sector asset purchases and even negative interest rates.

This ongoing willingness to provide monetary-policy support is a significant plus for European stocks in general, just as it has been here in the US.

Yet another reminder of that fact came this week with the testimony of Janet Yellen before the Senate Banking Committee on her nomination to succeed Chairman Ben Bernanke, whose term ends in January.

She indicated that she would stick to plans to wind down the central bank’s $85 billion-a-month bond-buying program in coming months if the economy picks up. But that’s a big if, as we’ve often advised. And she offered no timetable for when and how any tapering will occur.

“There is no set time,” said Yellen, who is currently the Fed vice chairwoman. “W! e have ma! de good progress, but we have farther to go to regain the ground lost in the crisis and the recession.”

As Yellen noted, the Fed still has a way to go in pursuit of its “dual mandate” for maximum employment and stable prices. Unemployment, currently at 7.3 percent, “is still too high, reflecting a labor market and economy performing far short of their potential,” she said. And inflation is below the central bank’s 2 percent target and will likely remain low for some time, she added.

What’s more, the Fed has continued to emphasize that short-term interest rates will remain low for a long time to come. And that may be even longer than generally expected now. The current position is that the Fed won’t raise rates until the unemployment rate drops below 6.5 percent. But an even lower threshold is being considered.

It’s no wonder that US stocks hit new all-time highs this week. Europe and the rest of the world also climbed.