European economic growth has been unexpectedly strong lately, driven by consumer spending. We believe this underappreciated trend has further room to play out, supporting the case for European stocks.
Eurozone gross domestic product (GDP) growth has generally been ticking up, exceeding U.S. and Japanese growth last quarter. Consumption, as evident in the chart above, has been a strong contributor to growth over the last year and a half and likely contributed to the first-quarter uptick. Easier credit, rising employment and greater purchasing power due to wage gains are driving this consumer recovery.
Consumption-driven growth ahead
We see consumption supporting eurozone GDP growth in the short term, according to new BlackRock Investment Institute research into Europe's prospects. Labor markets are improving in countries such as Italy, where reforms appear to be showing results. Many leading economic indicators point to stronger consumption. Also, a major headwind to growth is fading as European fiscal policy shifts from austerity to expansion. Another support: The European Central Bank (ECB) is likely to expand its asset purchases if warranted, rather than lower already-negative rates.
Eurozone growth does face longer-term challenges. These include an investment recovery held back by low corporate confidence and a weak banking system. Italian banks are still vulnerable despite recent actions. A worsening immigration crisis and a potential Brexit are near-term risks, but these appear at least partially priced into many underperforming European assets. The price-to-book ratio for European equities is 20% below its long-term average, while short sterling positions are increasingly crowded, according to our analysis.
Bottom line: Solid growth and easy monetary policy bode well for European risk assets in the short term. We are overweight European equities, but security selection is key given the challenges facing eurozone banks. We also favor some peripheral European sovereign bonds and see selected opportunities in European credit.
- The U.S. dollar modestly strengthened after five months of weakness, helping the performance of U.S. momentum and growth stocks.
- China released disappointing April trade data, and comments in a Communist party newspaper implied a greater focus on debt sustainability and reform. This points to slower near-term growth.
- A new interim government in Brazil should help boost investor confidence in the Brazilian market.
Weekly and 12-Month performance of selected assets
Asset class views
Views from a U.S. dollar perspective over a three-month horizon
This post originally appeared on the BlackRock Blog.