Europe Is a Glass Half Full

In the latest of several reports indicating improvement, the European Commission recently said that its Economic Sentiment Indicator for the euro zone moved into positive territory this month for the first time in more than two years.

European stocks have been rising for more than a year. Many markets, including those of  Germany, France, Spain, the UK and Switzerland, hit new 52-week peaks just last week. They were finally joining US stocks, which have steadily reached higher levels this year, officially broadening the global bull market.

Another sign of reduced financial stress is that yields on government bonds of Italy and Spain, two troubled national economies that are respectively the third and fourth largest in the euro zone, are down sharply from last summer. Plus, the yield spreads compared with German government bonds have shrunk from more than five percentage points to about half that level.

Last year’s turning point came when European Central Bank President Mario Draghi, perhaps taking a cue from US Federal Reserve chairman Ben Bernanke, said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.”

The main step the ECB took at that time was to fund Europe’s banks with necessary cash via low-cost loans to banks to buy government bonds. This stemmed immediate fears of a euro collapse.

Amid considerable ongoing speculation about the health of European banks, Draghi this week pledged to pump more into the banks if that becomes necessary to avert a possible a credit crunch.

Now, at long last, growth is starting to turn positive. The latest forecast from the Organization for Economic Cooperation and Development (OECD) is that overall growth for the 17-nation euro zone will be negative again this year. But the OECD has raised its forecasts for several countries.

Germany, Europe’s biggest economy, should gro! w 0.7 percent in 2013, up from the May forecast of 0.4 percent, the OECD says. And France, the second largest, is seen on course for 2013 growth of 0.3 percent this year, compared with a projected contraction of 0.3 percent previously. Outside the euro zone, the UK is expected to grow 1.5 percent, up sharply from the previous 0.8 percent forecast.

Pimco, the world’s largest fixed-income investor, predicts that the euro zone overall will generate slightly positive inflation-adjusted growth in a range between zero and 0.5 percent over the next 12 months. That’s anemic, to put it generously. Nevertheless, it’s an improvement over the 0.5 percent decline in gross domestic product for the year ending in this year’s second quarter. Outside the euro zone, the UK economy is expected to grow 1.5 percent to 2 percent in the coming 12 months, which is downright robust by comparison.

Among other projections, Standard & Poor’s forecasts that the euro zone economy will shrink by 0.7 percent this year, before growing by 0.8 percent in 2014 and 1.3 percent in 2015. Goldman Sachs expects a 2013 contraction of 0.36 percent in 2013, and growth of 0.87 percent next year.

Another plus: While the euro zone has now had eight consecutive quarterly declines in employment, the latest was the smallest yet, with a drop of just 0.1 percent.

This 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.

What’s more, many uncertainties remain about even the sluggish growth that’s expected. For instance, new data from the ECB showed that bank lending to companies fell in all of the euro zone’s big countries in August.

Last Sunday, Angela Merkel was elected to her third term as German chancellor, also strengthening her position as Europe’s de facto leader.
Sometim! es referred to as “Frau Europa,” Merkel is the only major European leader to have weathered the financial crisis. Her center-right Christian Democratic Union party fell just short of an absolute majority, but no German chancellor has achieved that since 1957.

However, she may have to form a coalition with the opposition Social Democrats, who likely would demand an increased focus on domestic issues, possibly reducing Germany’s enthusiasm for spending more to bail out weaker euro zone neighbors.

Meanwhile, France, Italy and Spain all face significant economic challenges, with troubled political leadership.

So Europe is improving. Its blue-chip stocks generally are attractively valued and pay good income. But the road ahead will remain long and bumpy.