Europe: recession over, crisis goes on

The eurozone may have emerged from months of economic contraction, but its stocks remain vulnerable.

"The eurozone is doing surprisingly well," says Richard Barley in The Wall Street Journal. The second quarter's GDP growth figure of 0.3%-1.1% annualised beat expectations and ended 18 months of recession. Recent business surveys suggest the positive momentum will continue.

Solid economic data and falling bond yields (in other words, falling borrowing costs) in the debt-soaked peripheral' countries have boosted sentiment. The pan-European FTSE Eurofirst 300 stock index has jumped 10% since late June. Spanish and Italian stocks are up 15%. Europe has outperformed America too of late, as its equity markets are more cyclical "and more exposed to low-quality financials", says Robert Farago of Schroders.

Will the bounce last?

More significant, however, is "the huge cargo tethered to the currency bloc's rear bumper", as Matthew Dalton puts it in The Wall Street Journal the "trillions of euros of private-sector debt" that Europe "has done little to address". The US appears to have managed to work off or write down enough of its debt to allow the private sector to start expanding again. But in many European countries consumers and companies remain weighed down by borrowings piled up in the boom years. Spain, Portugal, Ireland and Cyprus look especially vulnerable in this regard, according to the European Commission.

But "Europe's main problem remains its banking system", says the Financial Times. Damaged balance sheets are stopping banks from making loans and so are choking off growth. Unlike in the US, banks haven't yet owned up to the full extent of their crisis-related losses, and still need more money to guard against potential future problems. The credit squeeze won't end in a hurry.

654-eurofirst

Meanwhile, European policy makers are keeping quiet until after the German elections, notes Wirtschaftswoche. But with Greece and Portugal widely deemed likely to need more aid or debt relief, the crisis looks set to flare up again before too long. Political patience with austerity looks exhausted in the periphery, says Michael Diekmann of Allianz. That makes the situation all the more unpredictable. Therefore, it's not hard to see economic confidence, and hence stocks, taking a knock as politics moves centre stage again.

A solid long-term bet

cyclically adjusted price/earnings ratio (CAPE)

iShares FTSE MIB (LSE: IMIB)

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