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Economy in Brief

EMU Services Falter Further As Mfg Trims Losses Europe As Part Of A New World Order: But Which Part?
by Robert Brusca  September 20, 2012

The EMU FLASH PMI indicators moved in opposite directions in September. This should not be too much of surprise but neither should the results be misconstrued. And there is some danger in that.

EMU is not stabilizing as much as it rotating and these are very different things.

EMU became weak as the peripheral countries plunged into the abyss and were attacked by speculators. After various and sundry assistance plans and bailouts there is now a much bigger backstop fund available for use. So far- and the critical phrase is 'so far'- neither Spain nor Italy have been willing to undergo the humiliation of further austerity and the requirement that they cede sovereignty to IMF oversight over the conditions required for receiving help under the auspices of the new fund. But the fund is there and markets are beginning to price themselves for this assistance to be used. In the case of Greece there has been a five year long recession. Even there it is reasonable to have suspicions that things cannot get too much worse (or if they do it will be because prospects have gotten much better and Greece has left the Zone!). So the peripheral regions of EMU that have been dragging overall Zone growth down are showing less of a decline and the EMU drop for MFG at least is losing downward momentum. But this not the same as a bounce.

EMU Rotation Over the past five months among Germany, France, Italy, Spain, Austria, Greece, Ireland and the Netherlands, it is in Austria where MFG has fallen off the most. Germany has suffered the second largest drop in its MFG PMI and France the third largest. By absolute readings Greece is still the weakest and Ireland the strongest.

The top improving MFG PMI has been in Greece! Greece is followed by Ireland, The Netherlands and Spain. This is rotation in action! The relatively stronger core EMU members are getting sucked into the vortex and they will be footing the bill for the peripheral countries that will be getting help. The weaker peripherals that have been suffering will 'improve', but not by much in the months ahead as their rate of deterioration will slow.

In alphabetic terms we are looking for the 'V-shaped slide to transition to a 'U-shaped bottom-hugging experience for those in the periphery. At the same time we expect the 'V'-shaped drop in the core EMU countries to continue for a while. There may be a slight respite in their MFG drop this month but we would not expect that to last for the core members where they are plugged into a weakening global economy featuring a China slowdown as well as being dogged by continuing EMU issues and responsibilities.

In addition to that the services sector PMI reading fell this month and it fell sharply. The services measure made its 22nd largest m/m drop in the last 170 observations, a top 13% drop. Here again we see rotation at work. The data are not as clear since fewer countries report their individual service sector readings, but for those that do, in the last five months Germany's drop leads the pack at a drop of 3.77 points followed by Spain with a drop of 2.88 points and France with a drop of 0.90 points. Ireland at -0.44 and Italy at -0.28 'lead' the pack with the smallest service sector deterioration. With France and Germany ranking so high on this list of weakness you can see the point about rotation. I take the service sector drop as an imperfect proxy for a good chunk of domestic demand.

I have heard of some optimism among investors who see a smaller rate of decline in Europe and think it's a good time to invest there. Danger! Danger Will Robinson, to quote the folks from 'Lost in Space.' Not only is the slower deterioration based mostly on rotation (implying that it is the bigger markets where things will be getting relatively weaker in the near term) but it is unclear that the periphery countries will score much of a rebound.

I foresee a 'U'-shaped recovery for Europe (certainly for the periphery) because there are so many deep seated problems. The recent financing scheme can take pressure off short terms but to keep it off longer term the users of this credit will need to show progress. Joseph Stiglitz for one has been counseling Spain not to undergo any more austerity.

And there are huge competitiveness differences within the Zone across member countries and if the Zone is kept together there no is telling how these differences will be ironed out. If they are not ironed out the same old problems will continue to revisit the current struggling peripheral nations. If they ignore the problem, they will struggle. If they address the problem they will undergo a different kind of adjustment that will be an investment in their future but painful near term.

On balance I think the view of Europe as a place that is getting into the part of the cycle where the unraveling slows and it looks to be time to kick into an investment cycle is flawed. Europe is only dealing with the SYMPTOMS of its most short run problems. It is not really doing anything to heal the problem of the huge competiveness gaps. Betting that when this down-phase loses its intensity, growth will come soaring back will prove disappointing. There may be some short term 'pop' in markets as the worst of the down cycle passes but do not look for any extended upside. And remember that the core countries are going to continue to be leaned upon to finance the needs of the periphery.

China is not going to make up for weak European demand since it is going into a dither trying to replace lost export market demand with domestic demand- no easy feat. Japan is struggling under many burdens. While the US is also laboring of all the economic ills in the US, it can 'rather easily' solve these by itself. Its deficit problems can be fixed and with policy certainly in place it can grow its way back to prosperity. The new energy finds in the US give it a special basis for optimism and high oil prices make those businesses even more profitable and have provided incentive for some to move production closer to the end market in the US itself – even out of China. As China feeds its own domestic demand it will erode its own competitiveness and the US as a production platform will benefit from that to. It's a new world order unfolding so be careful which one you bet on.

FLASH Readings
Markit PMIs for the Euro-Area
  MFG Services
Sep-12 46.00 46.02
Aug-12 45.08 47.23
Jul-12 44.00 47.90
Jun-12 45.07 47.13
Segment Averages
3-Mo 44.72 47.05
6-Mo 45.48 47.05
12-Mo 46.63 47.85
173-Mo Range
High 60.47 62.36
Low 33.55 39.24
% Range 46.2% 29.3%
Range 26.92 23.12
Average 51.23 53.37
Queue % 11.1% 5.8%
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