Zew Index Stops Retreating: Pyrrhic Victory

There is a little good news in the Zew survey but it is still very little. The expectations index has stopped falling in December but its rebound is so slight it is hardly detectable on the graph.

Moreover, with the expectations index in the bottom 3% of its historic ordered queue (weaker than its current value only 3% of the time) the slight rebound is hardly much to cheer about. The current index continues to unravel. Here the bottom is a much more distant way away as it stands at a reading of 21% and is weaker than its current value about 79% of the time putting it still near the top 20% of its range.

So the German economy has slipped and expectations have been crushed but the actual economic situation, while off its bloom, is still relatively solid. Of course the ongoing deterioration and trend for the economy is in distress. But so far the reading for the current index suggests that Germany is having still a rather prosperous time but the dank expectations reading tells us that this is not expected to last.

Indeed, the current index still fell sharply this month, shedding 7.4 points, a faster decline than the 4.2 points it lost in November. So despite the rebound in expectations the current situation remains fluid and is deteriorating rapidly. Over the past 12 months the current index has lost 58.1 points thus the drop has averaged 4.8 points per month, just about the drop we saw in November. But the December drop of 7.4 points is a much more severe loss at a pace stepped up by about 50%.

There is not much in the Zew report to like despite the slowdown in the drop of the headline which actually is running into technical constrains since it cannot mathematically decline beyond a reading of -100. Its own historically-experienced range suggests that the potential downside is even more limited than that since the weakest reading on record is -63.9. The gap between the raw reading of the expectations index and the raw current reading (E-C) is about as wide as it ever gets to the downside. That implies that any further current weakness is liable to drag expectations lower as well.

Zew participants’ stock market profitability expectations across the whole of the German stock market segments have slowed their descent but continue to slip modestly and are doing so near the bottom of their historic range. Only banking insurance and construction sectors saw improvement in their expectations this month compared to November.

Although the German bond market is the strongest in Europe its assessment continues to be cut by the German financial experts. It was during this survey period that a Bund auction was undersubscribed compared to the amounts that Germany had expected to sell. The rating on bonds is the worst since April of 2011. It clear is reflecting some of the concerns in the Euro-Area itself

As for German stocks the Zew survey suggests that they track the current economy more than they look ahead to the future. The German stock market is not much of a discounting mechanism at least when put against the Zew expectations index. The correlation between the Zew current index and the DAX is 0.68 while the correlation with the Zew expectations index and the DAX is -0.25. Then again since this is a survey of financial experts, maybe it is the other way around: when stocks get weaker the financial experts see the economy as more depressed. The chart is not clear in that as sometimes the stock market seems to go first and sometimes the Zew current reading seems to go first. In any even the Zew current index and the German stock market are historically consistent in their assessment of what is going on. We would be wary, however, that the expectations index is still much, much, lower.