Eurozone Remains in Question - Ahead of Wall Street


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Wednesday, August 6, 2014

Stocks appear on track to start today's session in the red again, with soft economic data out of Europe raising doubts about the region's economic outlook. Threatening moves by Russia in its ongoing face face-off over Ukraine are also keeping market participants on edge. As a result, safe-haven trades into U.S. treasuries are pushing yields to the lowest levels of the year, offsetting Fed fears of recent days.

Italy's economy slid back into recession in Q2, and questions remain about the French and even the German economies. Italy's growth challenges aren't new - the country's economy has remained in the red off and on since the global finance crisis in 2008, and it barely moved into the green in the last quarter of 2013. Italy's growth problems are exacerbated by a huge debt and deficit overhang, the worst among the major Euro-zone economies. We will know more about how the entire region did in Q2 when Q2 GDP numbers for Euro-zone come out on August 14th, but the French economy has effectively been stagnant since Q1 and even the German economy seems to be losing steam.

Germany, accounting for almost a third of the region's output, isn't at risk of following Italy and France, but recent data indicates some loss of momentum in Q2. The weakness is particularly notable in the country's all-important manufacturing sector, with June manufacturing orders coming short of expectations.

What all of this boils down to is that the Euro-zone economy not only failed to gain strength in the first half of the year, but may actually have lost some ground. Perhaps the face-off over Ukraine, which is threatening to heat up again following reports of Russian troop movement, isn't so painless for the region after all. The region's economic slide will likely make it all the more difficult for the U.S. government to present a unified Western response to any fresh Russian moves in Ukraine.

The stabilization in the Euro-zone economy last year has been one of the bright spots in the global business landscape - and it has been showing up in corporate profitability measures. The overall tone of management commentary about business outlook in the region has been steadily getting better - and that is the overall takeaway from the ongoing Q2 earnings season as well. This could change, however, if the region's outlook starts deteriorating as a result of the Ukraine situation.

The updated Q2 scorecard, including this morning's releases from Ralph Lauren ( RL ), Devon Energy ( DVN ), and others shows that we now have results from 421 S&P 500 members that combined  account for 89.7% of the index's total market capitalization. Total earnings for these companies are up +9% from the same period last year on +4.6% higher revenues, with 65.6% beating EPS estimates and 60.9% coming out with positive revenue surprises.

As we have been stating repeatedly in this space since the start of this reporting cycle, this is the best performance that we have seen in more than year. This is having an effect on estimates for the current period as well, which aren't coming down as much as had been the case in other recent reporting cycles.

What's driving the earnings improvement? The resumption of U.S. economic growth is definitely a big factor. But stabilization in Europe and steady growth in China and other emerging markets have also been factors. Hard to tell whether the Russia-Ukraine situation could come in the way of the improving European narrative, but that certainly remains a risk.

Sheraz Mian
Director of Research
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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