Wednesday saw the release of the much anticipated euro area inflation and employment data. The year on year inflation rate came in at minus 0.2%, against an expected minus 0.1%. The core inflation rate, this is the rate that excludes energy prices came in at 0.8% year on year, slightly ahead of expectations. What in some ways was more significant is the unemployment level remains stubbornly high at 11.5%. The lead indictor to a broader recovery in the economic outlook for Europe should be a fall in the rate of unemployment. Equity markets bounced which commentators put down to the belief that this data took the ECB one step closer to introducing QE in Europe. It may also be that after several days of down markets a short-term bounce was in the offing.
One other factor that is starting to work in the favour of equity markets is that the markets are accepting the possibility that the Syriza party will come to power in Greece in a few weeks time. Its leader, Alex Tsipras, seems to be making an effort to calm nerves about his desire to see Greece on a path that would see it be forced to leave the euro. This may be an internal political move as well as an external one, as the bulk of the Greek population remains in favour or continuing with the euro, and perhaps any sense that he would lead the country out may harm his election prospects.
According to pre Christmas fund manager’s surveys, fund managers have positioned themselves in such a way that suggests they are anticipating the ECB to move early in the year on QE. There is a continual debate about the true benefit quantitative easing has had on the US economy. The original view held by many experts was that it would just push up commodity prices, that view has been proved spectacularly wrong. Along the same lines it would create rampant inflation, so far that has proved illusive. The third was that it would cause a bubble in stock prices. Stock prices in the US have risen but so have earnings, valuations may be a little stretched, but not wildly so (unless earnings start to fall). But if earnings start to fall, cheap or expensive stock markets fall.
Likewise the Stoxx 600 looks moderately expensive on historic valuations, as we have pointed out before, but unlike the US, corporate earnings in Europe still remain significantly below the 2007 peak (Merrill Lynch). If the global economy, particularly in the US, can continue to grow modestly, Europe starts to benefit also from monetary stimulus and lower energy prices, perhaps then earnings can start to recover back towards 2007 levels and those fund managers will be proved correct.