The November 13 terrorist attacks in Paris shocked the world. There were immediate effects in France, with hotel and tourism visits cancelled and attendance reduced at public entertainment events. In this note we offer some thoughts on the likely protracted effects on the French economy and equity market after the immediate shock wears off. There is a debate about the future growth rate in France.
This is my view. Others may expect things to be weaker.
The general consensus economic outlook for the Eurozone before the terrorists struck was for a continuation of the recovery at the moderate pace in 2016 of 1.6% (IMF) to 1.9% (OECD). That growth was expected to be supported by the 12% real depreciation of the euro since 2014 (with more likely to come), a 45% decline in euro oil prices, and easing monetary and credit conditions this year, leading into anticipated further easing by the European Central Bank (ECB) and a turn toward more accommodative fiscal policies. France, the Eurozone’s second largest economy, was expected to participate in the recovery, but with growth at 1.5–1.6%, less than the euro area’s average but better than the estimated 1.2% advance this year.
We now have the ECB’s December decisions adding onto its already highly stimulative monetary policy. We also have some important economic data for the full month of November, including reports from Markit, providing final data for the Purchasing Managers Indices (PMIs) for the Eurozone and France. The ECB surprised markets with the moderation of its moves. It reduced its deposit rate by just 10 basis points. While it extended the projected end date of its quantitative easing program by six months and expanded the list of securities it can purchase under that program to include what in the United States would be called municipal bonds, it did not increase the monthly amount it will purchase. Markets have reacted negatively to this surprise, but we see little reason to modify the outlook for the Eurozone economy: continued recovery at a moderate pace, with negative interest rates for at least another two years.
The November Eurozone Composite (manufacturing plus services) PMI indicates solid growth is continuing, with output, new orders, and employment rates all accelerating at or close to their fastest levels for the past four and a half years. The country with the highest PMI continues to be Ireland, followed by Spain. The country with the largest economy in the Eurozone, Germany, registered the fastest expansion since March. The report indicates that the strong aggregate result for the region “masks an ailing French economy. France was the only [Eurozone] economy to see growth weaken, the survey suggesting business activity remains moribund….” The French Composite PMI for November, at 51.0 – scarcely above the no-expansion mark of 50.0 – was a 3-month low.
Modest French Expansion
Disaggregating the French Composite PMI for November, the Manufacturing PMI, unchanged at 50.6 for the third month in a row, indicates very modest expansion, with stagnant new orders, a sharp drop in new export orders, continued cuts in staffing, and falling output prices. This relative weakness in demand has been evident for some time. The report includes the comment, “While there were no specific reports from surveyed manufacturers of an immediate drop in orders following the Paris attacks, the likely effect on consumer confidence will clearly not help….”
The French Services PMI for November was more mixed. Growth in services activity slowed somewhat in November, with some impact from the Paris attacks reported by hotels and restaurants. There were marginal reductions in employment, and prices charged by service providers continued to fall. However, new business growth reached a five-month high.
The terrorist attacks in Paris on November 13 and subsequent developments surely will have some negative effects on consumer and business confidence and tourism, but how much and for how long remain uncertain. Tourism is likely to be the sector most vulnerable to a change in sentiment. Tourism is important to France, accounting for 7% of economic activity (GDP) in 2014, generating some 150 billion euros in revenue. An admittedly rough calculation suggests that French tourism would need to decline by a third rather than advance the anticipated 4% next year in order to cause a recession in France. That steep a decline looks very unlikely for the country that leads the globe in attracting tourists. The effect on French business expectations, which already lack strength due to subdued demand conditions, will depend largely on the impact of the Paris attacks on consumer confidence. My view, discussed below, is that the effects, outside of the tourism sector, probably will be of short duration and limited in scope.
911 Comparison
Looking back at the significant impact of 9/11 on business and consumer confidence in the United States, could we expect similar effects in France? As terrible and shocking as the Paris attacks were, by any measure the 9/11 attacks on the US were much more severe, causing heavy destruction in our largest city, a severe strike on the headquarters of our military in our capital city, and the downing of a passenger plane in Pennsylvania, with a total death toll of 2,977. The events of 9/11 really were of a different order of magnitude, even after we take into account the difference in the size of our country. That difference alone suggests the effects in France will be different.
Moreover, in estimating the likely effect on French consumer and business confidence and changes in future behavior, we should recognize that the French, and particularly the citizens of Paris, have had a very different history than we Americans have. Not so very long ago Paris was occupied by Nazi Germany, and much of the Second World War was fought within France’s borders. During the Algerian War of 1956–62, there were numerous violent events in Paris. In the 1980s and 1990s my family and I were among the residents of Paris who feared they could be caught up in the terrorist attacks then occurring in the city, which, though not as large as the terrorist strikes of November 13th, were numerous and deadly. And just across the Channel there was IRA terrorism in London, while less than a day’s drive to the east there was war in Bosnia.
In Sum: Parisians have lived for decades with the dangers of terror the like of which we Americans have not experienced until recently. Their long experience has to make a difference in their reactions. They are shocked and saddened by the recent events but are probably rather less surprised than we were by 9/11. They will insist their government do more to provide security, and there will be some loss of individual freedoms, but a significant, sustained change in their economic behavior seems unlikely. Cafes, music halls, soccer stadiums, and stores will again be full. Life will go on.
The economic projection for the French economy of 1.5–1.6% growth next year does not appear to need significant adjustment. Any shortfalls due to weaker tourism and consumer demand are likely to be more than offset by increased government spending for defense and security needs.
ETF Outlook
This continued macroeconomic underperformance compared to the rest of the Eurozone economies does not necessarily mean that the French equity market, which is the largest in the Eurozone, will also underperform. This year to date (December 3), the iShares MSCI France ETF (N:EWQ), is up 2.15%, which is better than the 0.88% advance of the iShares MSCI EMU (Eurozone) ETF (N:EZU). In contrast, Spain, whose economy is growing almost three times as fast as France’s, has had a dismal equity market in 2015: the iShares MSCI Spain Capped ETF (N:EWP), is down 10.68% year-to-date.
At Cumberland Advisors, we have favored the iShares MSCI Belgium Capped ETF (N:EWK) for a single-country ETF, and it is up 12.11% year-to-date. This is impressive for an ETF that, like the other ETFs cited above, is not hedged against changes in the EUR/USD exchange rate. Where available, we continue to prefer to use currency-hedged ETFs for the Eurozone, such as the WisdomTree Europe Hedged Equity Fund (N:HEDJ), and the iShares Currency Hedged MSCI EMU ETF (N:HEZU), which are up 8.38% and 9.47% year-to-date, respectively. Despite the upward bounce in the euro following last week’s ECB meeting, the downward trend versus the US dollar still looks likely to reappear in 2016.
Bill Witherell, Chief Global Economist.