EU Economic Update – 20 October 2014

European markets sustain heavy losses amidst global rout; CNY and US economies also in the spot light

European equities fell hard last week as concerns over economic growth reached both US and Chinese shores, prompting a further rout upon indices across the globe.

In detail, the catalyst behind the extended sell off was the release of Chinese CPI data and US retail sales figures on Wednesday.

Here, CNY CPI fell from 2% down to 1.6% in a straight line while US retail sales, core retail sales and producer prices data each missed estimates; prompting concerns among investors that the world’s two largest economies were resting on the same shaky patch of ground as the European economies.

All in all, the week’s events saw peak to trough losses since the end of September extending to as much as 15% for some European markets.

In another reminder of how trigger happy the market can be in times of stress, the VIX Volatility Index reached its highest level since the height of the financial crisis in 2012 during the week, bringing gains in the index for the last 3 months to 78%.

These concerns were further highlighted when Greek 10 Yr bond yields surged higher to touch noses with the 8% level after the nation announced its intentions to exit the bailout program which it has been subject to since 2011.

Nevertheless, and despite what looked like a broadening picture of doom and gloom, markets pared losses toward the close on Friday as US consumer confidence, weekly unemployment claims and industrial production data all trumped forecasts.

Consequently, total losses for the period were markedly smaller than their peak to trough falls although, losses for continental indices over the period still amount to double digit figures.

In addition to this, the current week is expected to yield confirmation of a substantial decline in Chinese output during the third quarter, with official projections suggesting a deceleration from 7.5% during Q2 down to 7.2% for Q3.

If the above estimates prove to be accurate then investors could once again resume their panic over the health of the global economic recovery, particularly in light of elevated expectations for changes in monetary policy across the US, the UK once into 2015.

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Looking ahead

Looking ahead, we continue to see medium term support for European equities as a loosening policy environment supports reform and recovery efforts on the continent, while higher levels of output elsewhere in the developed world should eventually aid a recovery in corporate earnings growth.

Despite this belief, we acknowledge that recurring uncertainties relating to both monetary policy as well as growth potential elsewhere in the world have served to increase the risks attached to this play.

In order for Europe to remain a valid and attractive idea, growth in the US would need to remain stable leading up to, and throughout, the time when interest rates begin to rise.

In a similar manner to the above, Chinese policy makers will need to demonstrate an ability to guide the world’s second largest economy into a steady path of reduced, but sustainable growth.

Without either of these, investors are unlikely to remain convinced that the global economic recovery still has legs to go further for very long.

European Indices: FTSE 100 (Black), DAX (Green), IBEX (Blue)

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