Europe's Slow GDP Growth Rate Is The New Normal

by: Tim Worstall

Europe obviously offers space for new companies and new businesses - but not so much for growth of mature ones.

For a mature business to grow substantially requires considerable expansion of the market itself, of the economy.

Europe has managed to get itself stuck into a low growth paradigm, meaning those large businesses just aren't going to have outsized returns.

Business Growth And Economic Growth

There are, logically, two ways a business can grow - and thus make more of those lovely profits that we as stockholders then get. One is, obviously enough, that it's a business with a new angle, a new technology, doing something new. This can irrupt into the marketplace and grow by creating new demand for this new thing. Think Apple's success with smartphones, or Amazon's with online retail.

The second is that the economy itself grows. More people, or richer people, will lead to a rise in spending upon the old technologies, the old dependables. So, in a strongly growing economy we can expect to see constantly rising profits from the water, electricity, standard telecoms, firms, the supermarkets and so on.

The flip side of this is that in a near static economy then that second group just aren't going to be growing. Which is where I think the eurozone has got itself stuck.

Eurozone GDP

We've the numbers for eurozone GDP growth:

The first estimate of second-quarter euro zone GDP growth came in at 0.2% q/q, down from 0.4% in the first stanza and in line with our expectations. Growth from a year earlier also slowed, down to 1.1% from 1.2%.

The prediction is for:

GDP should grow by 1.1% this year, down from 1.9% in 2018.

Think about this for a moment. We regard 2.1% US GD growth as being sufficiently disappointing that people are calling a Fed rate cut. A growth rate low enough to threaten Donald Trump's re-election prospects perhaps. A fall to something just over 6% is regarded as a failure of Chinese economic management.

French GDP

We have the French GDP numbers:

Despite the slightly below-consensus headline, the results support our view that the French economy will grow solidly this year, with the continued momentum in domestic demand expected to offset any weakness on the external front. We forecast GDP will grow by 1.3%, down from 1.7% in 2018.

1.3% growth in France is regarded as solid.

We've clearly got very different expectations for these different economies. Which is the point that I'm making in fact. We regard American growth falling as low as 2.1% as bad. But think that 1.3% in France is solid. We have very different views of what each economy should be able to do. Again, my point.

Those old dependables in those eurozone economies aren't going to be producing decent sales or profits growth. Simply because the economies surrounding them are stuck in a low growth trap. This means our investing policy in that eurozone needs to be looking for the high growth companies, the technological irruptions. We're just not going to do well looking to the economic stalwarts in such near stagnation.

The Bright Spot - German Retail Sales

We do have one other number, German retail sales. This is not though as good as it looks:

German retail sales increased 3.5% in monthly terms in June, more than offsetting a revised decline of 1.7% in May.

That actually looks pretty good. Consumer demand is some 70% of a modern economy, retail sales a significant portion of that. People obviously have more money, they're out and spending it. Great, eh?

Except, well, not quite so much. The next sentence is:

The gain was largely due to base effects, particularly from the late holidays this year and the soaring temperatures that likely spurred consumers to spend more on items to beat the heat.

Base effects, well, the easiest way to think of them is as calendar effects. Sure, Christmas comes around at the same time every year and we can and do adjust our economic statistics for that. We want to know what is the trend after all, not that the Post Office has hired 300,000 people then fired them again 6 weeks later.

However, not all holidays do come around at the same time. Easter, for example, is the one Christian one that wanders and thus can affect different months in different years. Here what we're saying is that German holidays have moved around a little this year and that our effect on retail sales is mostly about that. Not an actual change in the underlying economy at all. Just the calendar.

So, it's not all that an exciting number after all.

Our Investor Takeaway

My reading is that we've - rightly - got low expectations for eurozone growth. Partly just because I think the euro was a bad idea in the first place and this is why. But over and above my own prejudices look at how Moody's Analytics, along with the rest of the financial press, is describing these varied GDP growth rates.

What is a disappointing US growth rate is regarded as a good and solid one for France. That shows the paucity of our expectations rather well, doesn't it?

In terms of investment this makes me insist that the big extant European companies just aren't going to be the ones growing very much. Simply because if you are a mature company in a mature industry then you are reliant upon general economic growth for your own growth.

This means that eurozone investments should be looking for new technologies, new companies, new areas of business. For old growth isn't going to be happening, it's only new growth companies that are going to be producing capital growth.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.