Where are European Stocks Headed in 2016

A Look at What's Driving the Eurozone Economy

Getty Images / Ian Egner / robertharding.

The Eurozone has struggled over the past few years, with the sovereign debt crisis being replaced by deflationary concerns. With the European Central Bank (ECB) firmly in stimulus mode and robust consumer spending, investors may see a stronger regional economy moving into 2016. But, the risk of deflation remains in place and the ECB doesn’t foresee reaching its 2% target until after 2017 – even assuming a modest recovery.

In this article, we’ll take a look at some of these trends and where the Eurozone economy may be headed moving into 2016.

Consumer Spending Rises

Household spending has been a strong economic growth driver for the Eurozone, accounting for about three-quarters of its growth during the first half of 2015. With rising consumer confidence over the same period, consumers maintained positive outlooks on their income potential while record low interest rates encouraged borrowing. These trends have continued during the third quarter of 2015 as spending accelerated further.

Retail sales have experienced their fastest growth rates since 1994 during the first half of 2015, but unexpectedly fell in September and October. The drop in retail sales came largely from a 0.4% in Germany and a 0.3% fall in France during October. Still, many analysts believe that it’s too early to tell if these data points are relevant or not in the context of the bigger picture – which has shown robust retail sales growth since the beginning of the year.

Exports & Investment Concerns

Emerging market turmoil is likely to take a further toll on the Eurozone’s exports, as countries like China buy less from the region. During the latter part of 2015, the region imported more than it exported by an increasingly wide margin. The euro’s falling valuation – particularly as the U.S. dollar appears set to rise – could help improve exports, but devaluations in some export markets (like China) could offset these gains at times.

Investment spending also remained flat through the end of 2015, as companies wait to see if the economy improves before implementing cap-ex spending. If the economy continues to show signs of improvement, these trends could begin to reverse as companies gain confidence in the economy. The ECB’s inflation estimate suggests that these trends could be a ways off, however, with a return to normalcy not anticipated until after 2017.

Deflation Remain a Risk

Deflation remains a significant risk for the Eurozone economy moving into 2016. When consumers believe that prices will move lower, companies begin to compete on price, and a downward spiral ensues. This creates problems since incomes tend to shrink for consumers and companies, while debt service obligations remain the same. These large debts can exacerbate the problem and make it even more difficult to stimulate spending.

After cutting its deposit rate further into negative territory and expanding its monthly bond-buying program, the ECB has been desperately trying to drive inflation closer to its 2% target without much success. The good news is that the threat of deflation is likely to keep the ECB’s stimulus measures in place, which could lead to robust equity performance, especially when the economy shows signs of long-term improvement.

Key Takeaway Points

  • The Eurozone has struggled over the past few years to grow, but robust consumer spending and central bank stimulus could point to a positive 2016.
  • Exports and investments remain a concern with emerging markets being at the core of the latter and business confidence leading to investment delays.
  • Deflation remains a key risk for the central bank to manage, especially with interest rates already in the red, but there are some upsides for investors.