Goldman: “Some European Economies Already Qualify As A Japanese-Style Stagnation”





Goldman: “Some European Economies Already Qualify As A Japanese-Style Stagnation”

For the longest time anyone suggesting that Europe’s economic collapse was nothing short of a deflationary collapse (which would only be remedied with the kind of a money paradopping response that Japan is currently experiment with and where, for example, prices of TVs are rising at a 10% clip courtesy of the BOJ before prices rise even more) aka a “Japan 2.0” event, was widely mocked by the very serious economist establishment, and every uptick in the EuroSTOXX was heralded by the drama majors posing as financial analysts as the incontrovertible sign the European recovery has finally arrived. Well, they were wrong, and Europe is now facing if not already deep in a triple-dip recession. Which also explains why now it is up to the ECB to do all those failed things that the BOJ did before the Fed convinced it it needs to do even more of those things that failed the first time around, just so the super rich can get even richer in the shortest time possible.

So we were a little surprised when none other than Goldman Sachs today diverged with the ranks of the very serious economists and the drama major pundits, and declared that “recent trends in some European economies already qualify as a Japanese-style stagnation.”


Full note from Goldman:

The Costs of Euro area Stagnation


Over the course of 2014, there have been important changes in the global growth outlook. The most noticeable of these have been mark-downs in GDP growth forecasts for some of the largest economies, including the US, Euro area, Japan and China. Within that set, the persistent sluggishness of growth in the Euro area has become an increasing source of concern in market discussions, as it appears to be tracking unpleasant patterns associated with the Japanese experience of the 1990s—leading commentators to hypothesize about a so-called ‘Japanization’ of the Euro area.


But the phenomenon of stagnation belongs to some continental European economies as much as it belongs to Japan. Recent trends in France, Italy, Spain and other countries in the region already qualify as stagnation experiences. Moreover, our historical analyses show that Western Europe has featured prominently in the list of the most serious stagnations.


In this Daily, we discuss three of the main costs associated with these experiences: (1) Growth wedges with respect to peers; (2) market underperformance; and (3) shortfalls in competitiveness. Our focus is on the most recent stagnation experiences looming over the Euro area, in an attempt to contribute to the debate with a more concrete assessment of how costly these experiences can be. This also has global ramifications: Consider that Japan’s weight in global output was around 9% when its stagnation started, compared with roughly 15% for the Euro area in the aftermath of the financial crisis. Thus, continued stagnation in the Euro area would be potentially more damaging for the global economy than Japan’s experience was back in the 1990s—because of its larger economic weight and the stronger financial linkages with the rest of the world. 


More Continental European Countries in ‘Stagnation’


Three years ago we argued that the risks that some of the largest economies would fall into a long period of stagnant growth had increased following the macro contractions and stock-market crashes we had just seen (GEW, ‘From the ‘Great Recession’ to the ‘Great Stagnation’?’, September 2011). Back then, we identified five countries in stagnation (Canada, France, Italy, New Zealand and Portugal) and noted that several more were at risk (including Austria, Australia, Belgium, Japan and even the US).


Fast-forward to today, and our most recent analysis finds three new cases of actual stagnation: Belgium, Spain and Norway (for the latter, the distinction between a non-stagnant mainland and a stagnant offshore economy are, however, relevant). On the brighter side, New Zealand is no longer in stagnation, while the US, the UK and Japan (for a change) appear to have come out of stagnation (GEW, ‘Still wading through ‘Great Stagnations’’, September 2014).


From that perspective, concerns around the stagnation of the Euro area are not entirely unwarranted: Average GDP growth in the Euro area over the 10 years leading to 2014 will likely print below 0.8% (or below 0.7% if we only take the last 5 years), which is similar to Japan’s 0.9% average growth during its stagnation experience (1992-2003). A large economy like Italy has experienced very little growth in GDP per capita even in the decade preceding the great financial recession.


Historical analysis shows that around two-thirds of stagnation experiences have occurred in developed economies, with a large fraction of these occurring in Western Europe. Moreover, among the most recent experiences, the most notable are precisely those of European economies (ordered by growth shortfall with respect to peer group): Spain (2008-13), Italy (2002-13), Portugal (2002-13), Belgium (2008-13) and France (2002-13).


The growth discontent: Wedges in GDP per capita between 10-30%


Recently stagnating economies in the Euro area have been growing at rates that are not only lower than their post-WWII average, but also substantially lower than their peers (economies of similar level of development judged by income quartiles). Over time, these differences in growth rates have opened sizeable wedges in levels of GDP per capita with respect to what they would have attained if they had grown at the average rate of their peers.


As of 2013, our calculations show that those wedges in GDP per capita are substantial: Spain (18%), Italy (27%), Portugal (21%), Belgium (13%) and France (18%). Among these, Italy is noteworthy. IMF data show that Italy’s GDP per capita as a share of Germany’s GDP per capita went from 96% in 2002 to 76% in 2013; the same share with respect to the US went from 69% to 57%; and even with respect to Spain it went from 109% to 102%. As a reflection of this stagnation, combined with the ascent of emerging economies to the global stage, Italy’s share of the world’s output has declined from 3.2% to 2.1% over the same period.

So with that in mind are you going to buy European stocks? Think again suggests Goldman:

The market’s discontent: Lower stock returns, higher bond returns

Our historical analyses show that stagnations tend to be characterized by lower stock returns and higher bond returns than normal (GEW, ‘A Market View of Stagnations’, October 2011). Recently stagnating economies fit those patterns. Total returns on stocks for these economies average -1.4% per year in real terms, considerably below the historical average of around 8%. In turn, total bond returns for these economies average 3.7%, above the historical average of around 3%. Finally, total bill returns have been slightly negative, at -0.2%, compared with a historical average of around 1%.

So the overall picture of financial returns in recently stagnating economies has been unfavorable for risky assets, with relatively low valuations (average Price/Earnings ratio at 13.9) and inflation lower than nominal yields (particularly once the zero bound has been reached), resulting in real rates above those in some countries’ trading partners. While global events over the past few years have affected the performance of the broadest asset classes across these and other developed economies, the underperformance of stocks in stagnant economies is a sign that market pricing reflects shortfalls in growth.

Wait, Goldman not pitching a buy? That can only mean one thing: the Goldman prop desk is buying European equities hand over fist ahead of the ECB’s QE, even as Goldman has been selling US equities with both hands over the past few months.