Recessions in Europe – we’d better get used to them

European recessions used to be few and far between. But as trend growth rates decline, recessions are going to become much more frequent. Investors need to get used to them.

The Eurozone economy has experienced only two recessions – defined as two or more consecutive quarters of negative GDP growth – since its founding in 1999: the Great Recession of 2008-09, and the European Sovereign Debt Crisis of 2011-13. Two recessions in 20 years seems like good going.

Looking further back to before the Eurozone’s founding, the countries that today make up the single currency bloc collectively experienced only three recessions between 1970 and 1999: in 1974-75 during the oil price crisis, in 1980 when tight monetary policy in the US sent much of the world into the doldrums, and in 1992-93 in the wake of another oil price shock and the US savings & loan crisis. Again, three recessions in almost 30 years seems like a reasonable record.

But as trend growth in the Eurozone economy – that is, the growth rate that economists expect on average most of the time – grinds ever lower, recessions are going to become a much more frequent occurrence.

Getting technical

One eloquent way of showing this is to compare trend growth with the standard deviation of growth. Before we do, however, a quick explainer on the standard deviation. Put simply, it measures the spread of a data set relative to the mean (or average). So, a low standard deviation indicates that the values tend to be close to the mean; a high standard deviation indicates that values are spread out over a wider range from the mean. To use a golfing analogy, a pro golfer chipping onto the green would have a low standard deviation (i.e. most balls around the hole); an amateur, by contrast, would have a higher standard deviation (i.e. balls all over the green).

Now, back to the economy. Our estimate of Eurozone trend growth is 1.3% per annum, declining to 1.0% over coming years. However, the 15-year rolling standard deviation of growth is 2.5% . The upshot of a trend growth rate that is below the standard deviation of growth is that a lot of quarters are going to see negative growth!

Indeed, using a little bit of statistics, we can calculate that for a normally distributed probability function with a mean of 1.0% and a standard deviation of 2.5%, the likelihood in any given quarter that growth is negative is 34% (see chart). In the early 2000s, the equivalent calculation yielded a much lower 10% probability of a contractionary quarter.

Moreover – and for the real stats geeks out there – this calculation assumes that growth is normally distributed. In reality, the distribution of growth is ‘fat tailed’. That is, there is a greater-than-expected probability of extreme values. Or, to go back to our golf analogy, more balls in the bunker. That means that quarters with negative GDP readings could be even more frequent than this analysis implies.


The bottom-line is that Eurozone investors will have to get used to a world in which growth contracts in one out of every three quarters. But they are not alone: equivalent calculations for other developed market economies yield similar results. After all, demographics in the West have become a bigger drag on economies. Productivity in numerous countries remains stubbornly low. Trend GDP growth is declining. Given these factors, it’s not surprising that contractionary quarters will only become more common.

Time to panic? We don’t think so. Rather, we believe investors need to adopt a different mind-set and stop treating recessions as all that important. In Japan, for example, contractionary quarters are already fairly run-of-the-mill. That, though, doesn’t detract from the attractiveness of investing in Japanese equities as, say, a play on the global economy (despite trade tensions, it remains the world’s fourth-largest exporter). Nor does it stop investors buying the Japanese yen as a safe-haven in times of stress.

Loose connections

A similar situation applies to Europe. For active managers, there remains a wealth of companies that can perform irrespective of what the economy is doing. Indeed, the correlation between European equity market performance and the region’s economic growth is lower than might be expected. Our analysis suggests that less than 25% of Eurozone equity market returns can be explained by Eurozone economic growth. It also shows that, in aggregate, under 50% of revenues for listed companies stem from the European Union.

Final thoughts…

So, European investors are going to face more frequent recessions. The good news is that most of these should be short-lived – to be viewed as a statistical artefact rather than the primary driver of investment decisions. Importantly, there are a raft European businesses that will do just fine even during times of negative GDP. Investors just need to keep their heads and look beyond the headlines. Time, in other words, to embrace the new norm.

Chart: Eurozone recessions are become more likely





The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.