Everyone seems to be pessimistic about Europe's economy, but that may actually be bullish for stocks and the euro

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  • Only a couple of years ago the European economic outlook was looking bright. Many expected the recovery would continue over the longer-term.
  • The reality is it didn’t. Growth slowed, surprising financial markets throughout last year.
  • With expectations for the European economy now so low, Morgan Stanley says that could help to trigger a recovery in European assets, and the euro.

In 2017, the European economy was looking good, showing clear signs of emerging from the funk stemming from the Eurozone debt crisis earlier in the decade.

The euro was strengthening, helped in part by strong capital inflows into the region as investors positioned for brighter economic times ahead.

However, that renaissance came to a shuddering end last year as economic growth slowed abruptly, surprising many who were expecting the exact opposite outcome to occur.

As seen in the chart below from Morgan Stanley, in all bar one week over the past year, European economic surprises were, as a whole, to the downside, marking the most pronounced stretch of economic underachievement seen since the GFC.

Morgan Stanley

“By February last year, the Eurozone economic surprise index had enjoyed its longest ever run of positive readings,” said Morgan Stanley’s European Strategy and Economics team in a note released this week.

“Since then, the same index has been negative for 51 of the last 52 weeks, which only previously occurred in the year to April 09.

“More depressingly, the Eurozone has had the lowest surprise index reading across all the major regions for 47 weeks in the last year — a level far above the previous high of 33 weeks seen in 2009.”

So even with sentiment being gradually lowered throughout the past year, the European economy continued to underperform, both from a regional and expectations perspective.

Such was the weakness, policymakers at the ECB were again forced to lower its forecasts for economic growth and inflation in the year ahead last month.

From the euro boom in 2017, it suggests many in markets are now expecting somewhat of a euro bust this year.

So it’s best to avoid buying European assets then, including the euro?

Not so says Morgan Stanley.

With expectations now so low, it says there’s a risk the economy may soon start to exceed what investors are expecting, an outcome that could help European assets outperform.

“Despite the recent growth downgrade from the ECB, we think the macro newsflow for Europe is about to get better,” Morgan Stanley said.

“The idiosyncratic drags on growth in the second half of last year are now fading — a rebound in China should feed in to Europe, wage growth is accelerating, and fiscal stimulus is picking up.

“In addition, if Brexit uncertainty abates, this could provide a tailwind.”

Given that view, the bank says it should be positive for both European stocks and the euro.

Since the end of February last year, the EUR/USD has fallen by over 9%. The MSCI Europe Index, even with the decline in the euro, has also fallen over 14% during this period.

“The future looks better for MSCI Europe, we think,” Morgan Stanley said.

“It normally rallies materially after a trough in the Eurozone manufacturing PMI, while the region also correlates positively to Chinese stocks and should benefit from any drop in Brexit uncertainty.”

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