This week, the economic news has been full of gloomy reflections on a very difficult quarter for financial markets. In Q3, stock prices have slumped by around 10% in the developed world and faster still in emerging markets, the sharpest falls in 4 years. Underlying this is evidence of a sharp slowdown in China’s real economy, which has been reinforced by jitteriness over looming US rate rises. The concern is that if the situation deteriorates, it will be a major setback to the fragile global recovery.
But this view is at odds with the recent economic data in Europe. In September, Eurostat’s Economic Sentiment Indicator improved markedly in the euro area and also in the EU as a whole. This optimism was shared across industry, services and retail trade, with only construction weaker. The lead markets were Italy, Germany, the Netherlands and France, all in the Eurozone core. So why are markets so gloomy when from this perspective it has been the strongest quarter in 4 years?
Sentiment bucks the market
Clearly, the global situation highlights the risks to the recovery and by implication to European real estate markets. But market noise obscures real progress in the Eurozone recovery in particular. This will not only allow it to better withstand the current storms, but will also bring upside to markets once the uncertainty clears. This is based on three important developments.
1. Emerging markets are no longer supporting global demand.
In the early stages of recovery from the 2009 slump, exports were all. This was because the major economies were repairing balance sheets and repaying debt and as a result, domestic demand was extremely weak. Emerging markets were less affected by the banking crisis and, in China’s case, benefitting from a huge domestic stimulus. They rebounded quickly and their demand propelled the initial export-led upturn in developed world demand during 2010-11.
But this momentum fizzled out in the Eurozone crisis. The global economy went into relapse until a slower, but new more broadly-based, recovery resumed in 2013. In this, world trade has grown far more slowly and domestic activity has made a stronger contribution. The result is a more balanced and robust expansion, closer to the pre-2008 norms. This does not mean Europe will feel no impact from China’s slowdown, but it does mean that it is now more resilient.
2. Stronger domestic demand is now fuelling Eurozone growth.
In the developed world, domestic spending generally drives activity and its lack of dynamism explains why the recent recovery has been so slow. But in the last year, fiscal easing, a weaker currency and the ECB’s QE programme have led to a turnaround.
This has had a positive impact, not only in sentiment, but also on the hard data. Job creation has blossomed over recent quarters, even in markets such as Italy where recovery previously lagged. Incomes have languished for years, but this brings hope that real wage growth will return, following the UK’s lead. Such “domestic healing” is another sign of a return to normal and is vital for a sustainable recovery in the region. It is also essential to further reduce Europe’s reliance on other parts of the world.
3. There are offsetting upsides for Europe from the global upheaval
The impact of China’s slowdown on trade is direct and negative, but other effects are helping to offset export losses. Commodity prices and interest rate impacts are most important. The sharp drop in oil prices has brought a one-off boost to European consumers’ spending power, cutting non-discretionary fuel and energy costs. Given its importance to global oil demand, China’s concerns can only prolong this trend.
A month ago, a rate hike by the Federal Reserve at September’s FOMC was seen as odds-on. But policy-makers chose to delay this in light of events. On balance, a US move still looks likely before the end of this year. Similarly, in the light of weak UK inflation and global risks, Bank of England statements have become less bullish. Markets expect no rise before mid-2016. While rates must eventually revert, signs of Central Bank flexibility are helpful in keeping the recovery on track.
In summary, the deceleration in China and Fed tightening will likely have downside impact. But these are the sort of setbacks that occur in every cyclical upturn. Europe, and most importantly the Eurozone, can now absorb these much better than in the recent past and should continue to recover without serious loss of momentum.
For real estate, the implications are still broadly neutral. Our forecasts for the revival in commercial demand and rents remain cautious and recent events are not yet enough to derail this. At the same time, the latest data also make us more confident that a durable economic recovery is in place and that market upside could return sooner than expected. In an environment of tight supply, this can quickly lead to upward rental pressure, as we have seen in Dublin, London and Madrid.