Why are Euro area bond and equity markets diverging from their economic performance?

Today I wish to examine something of a dichotomy which in the Euro area is that gap which has appeared between the performance of financial markets and that of the real economies. Let me give you the first example which is of equity markets. Yesterday when it hit 1122.59 the FTSE Eurofirst 300 equity index came within a decimal point or two of  what would be a twelve month high. It is 14% up on a year ago and up 12% this year. Now this index is not a pure Euro equity index as there are UK companies in it but we do not lose the thread as the UK is only up just under 7% on a year ago so others have done better.  Indeed the German DAX up nearly 26% in 2012 so far and the French CAC 40 up 13% in 2012 have done better. Believe it or believe it not but the Athens General Index is up nearly 19% in 2012 and the Italian FTSE:MIB is up 5%. Not every market is up as the Iberian Peninsula has had a harder time but overall equity markets have risen in the Euro area in 2012.

Government Bond Markets

Ordinarily a rising equity market is associated with a falling bond market as hopes for a strengthening economy and hence higher equity prices means that a given bond yield becomes less attractive. However as equity markets have risen in the Euro area so have many of the bond markets including the peripheral ones.

As we have economic data on these four countries today which I will discuss in a moment let me show you France, Greece, Italy and Portugal. In 2012 the French ten-year bond yield has dropped from 3.24% to 2.03% today which I have summed up this morning on twitter thus #somuchfordowngrades (of which she has received two in 2012). Italy has seen a sharp fall in her ten-year bond yield from 7% to 4.5% and Portugal from over 13% to 7.6%. The situation is more complex in Greece because of the debt haircut in the spring of this year but since June her ten-year bond yield has dropped from over 30% to 16.3% now.

Reviewing such numbers we do indeed begin to find a possible solution to a part of the dichotomy here as we see that lower bond yields may well have supported equity markets  via making dividends look more attractive and looking at the causality that way works much better than the alternative.

The Real Economy

However as we look at the real economies of these nations we know that this has been a difficult 2012 at best and for some a truly shocking one in economic terms.


Today we have seen the release of the latest unemployment data which is shown below.

Istat estimates that 22.9 million persons were employed in October 2012 (provisional data). Employment rate was 56.9%, unemployment rate 11.1% and inactivity rate 36.0%.

What that does not tell you is that unemployment rose by 97,000 in a month raising the unemployment rate by 0.3% to what is a high for a monthly reading. It has now risen by 644,000 or 28.9% in a year. We also see that employment has fallen from its recent peak of 23.05 million in January to 22.93 million now.


We are seeing more and more examples of weakness here too.

In October, households expenditure on goods decreased by 0.2% in volume*, after a stability in September. In particular, the increase in purchases in durables did not offset the drop in expenditure on tobacco products.

This is down 0.5% on a year ago. Whilst this is not a large drop I have highlighted it because it looks like an early example of the downwards push that Euro area austerity gives to an economy.This is because tobacco taxes have risen.

But we only need look back to Wednesday for more worrying news.

In September 2012, the turnover fell significantly in the manufacturing industry (–2.7%), after a rise over the last two months. Exports declined dramatically (–4.2%).

In September 2012, the turnover of industry as a whole went down by 2.1%. Over the same period, it also declined in construction (–2.8%).

So we can see that it looks as though the French economy has now turned downwards after a 2012 which so far has been officially reported as stagnation to minor growth. The turnover figures above finally confirm what we have read in the business surveys and from them we know that there should be more weakness to come.


It is becoming increasingly difficult to describe the scale of the destruction which has been inflicted on Greece’e retail sector which is increasingly looking as if even the word depression is inadequate so at this point I will let the numbers speak for themselves.

The retail trade volume index, including automotive fuel, decreased by 12.1% in September 2012 compared with September 2011. The Index in September 2011 recorded a decrease of 6.5% compared with September 2010

This means that the underlying volume index is now at 70.9 where 2005=100. September’s number was 7.3% weaker than that of August.


We see from today’s update on European unemployment that the unemployment rate in Portugal in October has equalled its recent peak of 16.3% which is up considerably on its 13.7% of a year before. Also only yesterday her statistics agency told us this.

The Consumer confidence indicator decreased significantly between September and November, attaining the minimum of the series.

The economic climate indicator diminished strongly in the last three months, recording the lowest value of the series in November.

It is a reflection on Portugal’s economic history that the consumer confidence indicator which began in September 1997 has never had a postive reading! The peak was -5.5 in November 1997 but we are a long way from that now with a reading of -59.

These numbers are summed up in the economic climate indicator which began in January 1989 and had a peak of 5.3 in April of that year. However it registered an all time low in November as it fell to -5.0. For further perspective we see that this index has averaged 1.5 over its lifespan and that in the initial pre credit crunch contraction it did not exceed -4.


So we see that the evidence for the real economy provides little support for the equity market revival and in truth would often be associated with a decline. There is a clearer link between economic weakness and a bond market revival however and this could have an effect on equity markets as yields drop. However some of the countries are seeing an economic decline so pronounced that they too are likely to need a debt haircut which would cut off  bond market investors at the knees if not higher.

On the other side of the coin we have developments in the monetary economy where Mario Draghi and his colleagues at the European Central Bank have been doing their best to “pump it up” in 2012. We have seen an interest-rate cut combined with various acronyms such as LTROs (just over a trillion Euros) and OMTs (so far just an illusion). So are equity markets closet monetarists? If so they will have been cheered by yesterdays money supply growth numbers for October  which looked strong albeit concentrated yet again in the core nations. So we find ourselves back at a familiar question which is how this impact will be split between real growth and inflation. Also will it be strong enough to offset the effect of additional austerity measures?

But as ever if we take the monetary route and tick the box for equity markets how do we then explain bond markets? We come back to a familiar theme which is that there is so much meddling in markets these days by authorities it is like trying to look to the bottom of a muddy pool. As ever I will be interested in readers thoughts on this…



This entry was posted in Euro zone Crisis, General Economics, Greek Financial Crisis, Interest rates, Quantitative Easing and Extraordinary Monetary Measures, Recession and tagged , , . Bookmark the permalink.
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  • Anonymous

    Hi Shaun,

    Cash looks risky in an environment when the very continuity of the euro is uncertain. Add to this the risks of bank failure, default and inflation and I conclude cash and bonds are badly overpriced. With all the central bank market manipulation – we should be very sceptical of the price information we receive from this market.

    Equity looks better than cash / fixed income bonds in an inflationary environment. I think this market isn’t subject to large scale manipulation and so we should have more trust in it’s market values.

    Maybe your dichotomy is caused by bad input data …

  • forbin

    Hello Shaun,

    I though all the bond markets were loaded ? All that AMER and EMEA funny money…. with more printing to come.


  • Rods

    Hi Shaun,

    An excellent piece of analysis.

    I think the rise in the equity markets has been on the basis as a least worst place to park your money, especially if it is there for the longer term so you aren’t too concerned about short term volatility, but what will be the longer term trends.

    If you have money to invest and have the outlook that QE and other currency debasement to make sovereign debts affordable is inevitable, then where would you place your money?

    The only way the bond markets make a bit of sense to me is:

    1. They are perceived safe haven
    2. fixed market. QE or like with the buy-back scheme, a possible place by buying low, and selling higher to make a quick buck.

    If I was looking to invest my priorities would be making sure I got the money back and having a hedge against rampant inflation as even the safe havens, when things start to improve will generate losses through currency devaluation.

    Things are beginning to look very grim in several countries especially Greece. Do the EU and other political elite realize the hardship they are imposing on many hard working people, I doubt it and do they care as long as they have a good life, almost certainly not.

  • James

    I think that your analogy of looking at a muddy pool is far too kind to the level of interference by governments etc in these markets.
    After all, you have government or central bank purchases of
    1. £375 billion in the UK
    2. $1 trillion in the USA (more?)
    3. Euro 1 trillion in LTRO
    You have government agencies owning banks and setting the rules for capital ratios, including the rules relating to whether government securities qualify as part of those ratios. You have government debt burdens reduced by the “profits” on the interest earned by central banks, which nevertheless hold bonds at par even where they are trading at 20p in the pound. You make private sector investors take large losses on bonds, while exempting ECB etc. You make Greece buy back its bonds in order to get the next IMF bailout.
    And lastly, of course, you set interest rates so low that equity dividends start to look attractive.
    Those wicked bankers castigated by the politicians would, of course, be gaoled were they to act like this, but there we go.

  • pavlaki

    I have often observed that the markets, bond, equity and in particular forex react dramatically to any positive news ( or even the absence of bad news) as if they are desperate to pile into the Eurozone given the slightest excuse. Perhaps it is Euro fatigue? Everyone is immune to further bad news so good news is seized upon. A psychological knee jerk reaction?

  • Anonymous

    Hi James
    I agree that I may well have been too kind to them. We have markets which have in many ways been meddled with. Some investors have done well out of this and well done and good luck to them but I see more and more fund managers with good track records retiring when they do not need too.
    I believe that a major factor behind this is that guessing what governments and central banks will do next is the main and at times only game in town.

  • Anonymous

    Hi Expat

    You might be right about bad input data after all what data is reliable these days. But on the subject of equity markets how do you respond to the point that James made above?

    “And lastly, of course, you set interest rates so low that equity dividends start to look attractive”

  • Anonymous

    Hi pavlaki
    Some years ago a colleague explained it to me as equity markets “climbing a wall of worry!” So there may be some consistency in that although it has to be a finite explanation as if the problems persist shares cannot continue to climb.
    I think that you are right to point out that the expectations set for the Euro area is now so poor that even weak results can exceed them!

  • Anonymous

    Hi Forbin
    Your view of “more printing to come” puts you on the other side of the argument to Adam Posen. You shoud be heartened by this as this is usually a fairly safe place to be…..

  • Anonymous

    Hi Rods
    You make a good point about equities being perhaps the least worst place. Over the crdit crunch era it has often come down to that has it not? Something of a loss of ambition in itself….

  • Anonymous

    James point about the dishonest politicians is precisely correct. I believe that a country’s wealth is co-related to the amount of corruption within it’s politicians & bureaucrats – Norway has oil wealth and is rich and well run, Nigeria has oil wealth, according to transparency intl it is badly run and the people are poor. The UK is sort of in the middle of these 2 – and transparency Intl agree with my assertion.

    When we see the UK politicians engaging in deceit (they certainly do not tell us honestly about the deficit and QE) – I can only suggest that the UK’s corruptions perception placing should be expected to get more corrupt and the UK will become a poorer place.

    The economic policy mess that you describe very well in your excellent blog is a symptom of rotten government.

    I suggest the remedy will require courageous British politicians willing to publicly face up to our overspending problems and tell us the hard truth – real austerity is needed. Honesty is needed. Tough decisions are needed. Canada has shown this can be done, but the Greek politicians “I’m alright jack” but you need to suffer approach is the highway to hell ….