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European Review: 3Q 2011 GDP Dodges the Bullet November 17, 2011
Despite failing to accelerate as an economic bloc, sufficient expansion in the core economies of Germany and France managed to offset stalling Spanish and Belgian economies as well as contractions in Greece, Portugal and the Netherlands.
Author : iFAST Research Team

Untitled Document

Key Points:

  • Although 3Q 2011 GDP came in better than expected, we believe that Europe is still poised for a mild recession
  • Core nations managed to uplift the region into positive growth territory
  • European Commission has slashed growth forecasts for the region in 2012
  • Financial sector has been clobbered, with accelerating job cuts and a reduction in lending
  • Earnings for 3Q 2011 have fallen by -12.55% on a year-on-year basis
  • Our revised conservative estimates forecast potential upside of 26.6% by 2013
  • We maintain the European equity market's rating at "3.0" Stars

reviewing 3q 2011 gdp

The Eurozone’s advance estimates for 3Q 2011 GDP saw the continent’s economy grow by 0.2% on a quarter-on-quarter basis and 1.4% on a year-on-year basis. Despite failing to accelerate as an economic bloc, sufficient expansion in the core economies of Germany and France managed to offset stalling Spanish and Belgian economies as well as contractions in Greece, Portugal and the Netherlands.

In France, GDP strengthened on a quarterly basis from a downward revised -0.1% contraction in 2Q 2011 to a 0.4% growth rate in 3Q 2011 on the back of a rebound in consumer spending and improved industrial production. On a year-on-year basis, economic growth measured 1.6%. Despite the seemingly positive news, business investment showed a contraction of -0.3% on a quarterly basis. On a year-on-year basis, the growth rates of several key indicators such as household consumption, business investment and exports decelerated, suggesting a potentially trying period ahead with budget cuts to come and the spill-over effects of the sovereign debt crisis to deal with.

Across the Rhine, Germany saw its economy grow by 0.5% in 3Q 2011 following an upward revised 0.3% growth rate in 2Q 2011. Similar to France, household spending drove economic growth while business investment also contributed positively. While we had called for a quarter of negative growth in 3Q 2011, we had conservatively assessed Europe’s economic situation with strict confines due to extreme uncertainty in financial markets and an apparent soft patch in global economic growth spelling stronger headwinds for the continent.

While we’re “glad” to be wrong about 3Q 2011, it appears that both consensus, the European Commission and the European Central Bank have likewise downgraded growth prospects for the continent in the face of extremely challenging times. The European Commission has reduced their growth forecasts for 2011 and 2012 from 1.6% and 1.8% in August to 1.5% and 0.5% respectively with 2013 GDP expected to grow 1.3%. The European Commission’s comments of “the probability of a more protracted period of stagnation is high...a deep and prolonged recession complemented by continued market turmoil cannot be excluded” echoes the ECB’s warning of the risk of a “mild recession”.

While the stark warnings coming out of the European official bodies might sound terribly depressing, we believe it is targeted at the key politicians of the individual nations to hasten the speed of their actions to reassure markets, introduce reforms and formulate a credible fix to the crisis. Looking at our initial forecasts, in retrospect, perhaps we too were affected by the tsunami of negative sentiment and were a tad aggressive in cutting our growth expectations given that hindsight is very often 20/20. We have subsequently re-evaluated and reconsidered the various data and factors and have tweaked our forecasts slightly in light of the latest market information and happenings (table 1).

Table 1: Continuing to err on Caution's Side

Time Period

Real GDP Growth (QoQ)

Real GDP Growth (YoY)

Est Annual Real GDP Growth
1Q 2011 0.84% 2.46% 1.45%
2Q 2011 0.20% 1.70%
3Q 2011 0.20 1.41%
4Q 2011* -0.75% 0.39%
1Q 2012* -0.45% -0.84% -0.60%
2Q 2012* 0.60% -0.40%
3Q 2012* -0.25% -0.85%
4Q 2012* -0.20% -0.30%
1Q 2013* 0.40% 0.55% 0.99%
2Q 2013* 0.45% 0.40%
3Q 2013* 0.35% 1.00%
4Q 2013* 0.80% 2.01%

Source: Bloomberg, iFAST Compilations
*Denotes IFAST forecasts/estimates
Data as of 15 November 2011


Still Calling for a Reduction in Capital Formation, Government Expenditure, but not Exports

Amongst the different components of GDP, we had expected a drop in capital formation, government expenditures and exports. We had previously initially highlighted a potential increase in capital formation (corporate investment), followed by believing that capital formation was due to decrease due to leading indicators for business confidence falling as well as sufficient existing spare capacity. The positive surprise in business investment might not last long, given the probable continued fall in industrial new orders during 3Q 2011.Although government expenditure has yet to fully be impacted despite the ratification of several budget tightening and fiscal measures, government expenditure is still expected to contract further from current levels given the budget cuts and austerity measures being implemented by nations such as Greece, Italy, Spain and France.

The outlook for exports brings better news for economic growth. With the notion that the global recovery was seemingly stalling now put to bed with major economies like the US reporting positive growth surprises and China averting a “hard landing”, we believe exports, one of the key drivers of the recovery, could improve on the back of a weakening Euro (which has fallen by -9.21% against the USD since its highs in April 2011, as of 16 November 2011) and the avoidance of a “double-dip” recession in the global economy.


Across the Eurozone, many of the leading indicators as well as sentiment surveys and the important purchasing managers index (PMI) have shown significant declines into contraction territory (a reading below 50 indicates a contraction) as previously mentioned. However, despite these declines in sentiment and surveys, reality has obviously been different with a divergence between these traditionally leading economic indicators and economic data. Despite being in negative territory not seen since August 2009 and April 2010 respectively, consumer confidence and industrial confidence levels have not translated into dampened private consumption as well as industrial production. 3Q 2011 GDP for the Eurozone showed stronger than expected consumer spending and industrial production, which were responsible for dragging GDP into positive growth territory, with much of the growth originating from the resilient engines of European growth – France and Germany.

As industrial production in Europe had been clearing a backlog of old orders, production levels were able to avoid contraction. Given that new industrial orders are likely to have fallen in 3Q 2011, we continue to remain cautious on a possible reduction in industrial production. Similarly, we remain cautious on retail sales in Europe as on a year-on-year basis, retail sales have been in decline since May 2011 and recent month-on-month sales for non-food products have shown signs of a declining trend.



Previously, we had argued that the sovereign debt crisis would infect the financial sector with the real economy being ultimately impacted. As it is, European banks have announced further job cuts as they seek to tighten their belts amidst difficult times whilst deleveraging their books. In addition, according to the ECB’s Lending Survey, demand for loans or credit lines by enterprises and consumers have declined by approximately -8% and -15% respectively, a potential sign of the initial impact on the real economy.

As a by-product of having to raise their Core Tier 1 equity ratio to 9% by June 2012, the ECB Lending survey has indicated that banks across the continent have been tightening their credit standards for enterprises and consumer credit as they seek to shore up their capital base which could lead to a further drop in new loans given to enterprises and consumers. Furthermore, reports coming out of Europe indicate that banks have begun to shed Italian debt, hopefully avoiding “voluntary” haircuts they took with Greece, as yields on the Mediterranean nation’s bonds continue to rise, complicating the prospects of a resolution to the current rise in sovereign yields and heightening contagion risks.


In our September article, we had forecasted a -1% contraction in GDP over the next 12 months and had expected earnings of the Stoxx 600 to decline substantially. Following adjustments to expectations and incorporating the latest round of quarterly earnings in the Stoxx 600 (311 out of 324 companies reported earnings averaging a -12.55% growth rate), we have revised upwards our expected European earnings for the year as the anticipated fall in earnings in 3Q 2011was not sufficiently large enough to warrant our previous beliefs for 2011 as a whole. Subsequent earnings growth projections for Europe have been delayed, with stronger earnings growth previously expected in 2012 now pushed back towards 2H 2012 and 2013 as seen in Table 2 on the back of the likelihood of Europe continuing its muddling of temporal solutions prior to finding an answer to its political and structural issues.


Time Period

Consensus Earnings

iFAST initial Estimates
(12 September)
iFAST Estimates
(15 November)


Discount to Consensus (%)
1Q 2011 24.65 - - 24.5 -
2Q 2011 24.50 - - 23.91 -
3Q 2011 23.91 19.17 19.17 20.89 -19.82%
4Q 2011* 23.08 17.32 19.71 - -14.60%
1Q 2012* 23.66 18.17 19.88 - -15.97%
2Q 2012* 24.24 19.03 20.05 - -17.27%
3Q 2012* 24.82 19.88 20.23 - -18.51%
4Q 2012* 25.40 20.73 20.40 - -19.69%
1Q 2013* 26.05 21.82 21.30 - -18.23%
2Q 2013* 26.70 22.90 22.20 - -16.84%
3Q 2013* 27.34 - 23.10 - -15.51%
4Q 2013* 27.99 - 24.00 - -14.25%

Source: Bloomberg, iFAST Compilations
*Denotes forecasts/estimates
Data as of 15 November 2011

We now expect 2011 earnings to contract by -11.6%, with earnings growth of 3.5% in 2012 followed by a healthy 17.7% rate in 2013. Based on current valuations as of 15 November 2011, Europe’s price-to-earnings is currently valued at 12X, 11.6X and 9.9X for 2011, 2012 and 2013 respectively. This is in comparison to consensus growth estimates of 3.4%, 10.2% and 10.2% for the same time frame and PE ratios of 9.3X and 8.5X for 2012 and 2013. Based on our more conservative earnings estimates, Europe’s potential upside currently stands at 26.6% by 2013 (as of 15 November) when compared to its fair value PE of 12.5X.

Despite increasing signs of contagion, we remain confident in the ability and political will of key political leaders in Europe to resolve the issues plaguing the continent especially with new leaders in Italy and Greece and the potential international involvement of various central banks and international organisations. The move by the European Central Bank to cut rates by 25 basis points in November as well as on-going negotiations to bring forward the launch date of the European Stability Mechanism (ESM) from 2013 to 2012 lends optimism amidst the usually negative headline emanating from Europe. We expect further rate cuts from the ECB as they attempt to stave off or lessen the impact of the impending recession. We also expect progress in the political scene and see a possibility of further political integration in Europe slowly taking shape.

We maintain Europe’s star rating at 3.0 Stars – Attractive as despite the sovereign debt crisis currently being primarily a crisis of confidence and/or liquidity and not solvency, valuations are attractive at current levels. Our Recommended European fund, HENDERSON HZN PAN EURO EQ A2 EUR, has seen its positioning underweight tricky sectors such as Financials and the Consumer Discretionary sector while overweighting more defensive sectors such as the Healthcare sector.

With the European issues unlikely to be fully resolved in the short run, investors might like to consider lessening their targeted portfolio allocation towards the troubled continent and look at the 5 Star – Very Attractive rated Asia Ex Japan and Global Emerging Markets regions.

Recommended Europe Equity Funds:


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Europe: Under Recessionary Pressure
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Looking Past The Current Turmoil - Upgrading 12 Markets; Downgrading Europe


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Janus Henderson Hzn Pan Euro Eq A2 EUR

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