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Euro Zone PMIs Validate Bond Bull Thesis


Euro Zone PMIs Validate Bond Bull Thesis

We forecasted at the beginning of 2023 that the US would avoid recession but the Euro Zone would crack under the pressure of hawkish central bank monetary policy.  This morning the December Euro Zone PMIs came out and were weaker than expected with the manufacturing PMI coming it at an extraordinarily weak 44.2 and the composite PMI at 47. 

 

Readings below 50 indicate a contraction in economic activity.  The Euro Zone GDP Now is currently at -1.2% for the quarter and is likely to go down after the release of the PMIs.  In addition, the Euro Zone economy shrank last quarter as well indicating a recession is underway. 

 

We believe that the ECB economic forecast of .8% growth for 2024 is widely optimistic as the rebound in growth is predicated on a rebound in consumer spending.  This is extremely unlikely as Euro Zone consumers are under extreme pressure from higher interest rates as 45% of European mortgages are floating. In addition, recessions are driven by investment spending declines the housing and manufacturing sectors are in rapid decline and unemployment is rising.  We continue to believe that the ECB will be the first central bank to cut rates even though it doesn’t understand that yet.

 

The weak Euro Zone economy validates our 2024 target of 3-3.5% for the 10-year treasury for the US in 2024 driven by global central bank rate cuts.  Right now every OECD country has interest rate futures market implied cuts with the average cut expected to be over 1.25%.  We are recommending investors focus on buying the broad financial sector which includes preferred stocks, banks, and REITs as these sectors have been massively oversold during 2023 due to the regional banking scare and the increase in treasury rates to 5%.  Our target for the S&P is 5,500 based on a 20.5X multiple of estimated 2025 S&P earnings of 270.  The 20.5x multiple is our estimate of the fair value multiple for the market at a 3.5% 10-year rate based on a DCF model.

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