Recent data suggest that France could be experiencing economic contraction.
Things are beginning to look bad for France. The chart below represents the performance of the iShares MSCI France ETF (NYSEARCA:EWQ) during the past six months. This ETF is designed to track the performance of the MSCI France Index. The MSCI France Index measures the performance of the large and mid cap segments of the French market. With 73 constituents, the index covers about 85% of the equity universe in France.
As I indicated with the red bar on the chart, EWQ experienced a “double top” with peaks in mid-September and mid-October, signaling that a decline was on the way. (Chart courtesy of Stockcharts.com.)
After gasping for air on November 1, EWQ broke below its 50-day moving average (currently $21.58) and it has been sinking ever since. As of this writing, EWQ is at $21.10, halfway between its 50-day moving average and its 200-day moving average of $20.38 – which could be its next target. If EWQ breaks below its 200-day MA, the next target could be its July 24 support level of $17.99.
So why is there so much bearishness about France?
On November 7, the global equities markets swooned after the publication of a remark by European Central Bank President Mario Draghi during a speech at the economic forum in Frankfurt. Draghi warned that although Germany has been largely insulated from the economic difficulties experienced elsewhere in the Eurozone, “the latest data suggest that these developments are now starting to affect the German economy” (NYSEARCA:EWG). On the following day, a report released by Destatis revealed that German exports declined on a monthly basis by 2.4 percent in September, despite economists’ expectations for a less-significant, 1.5 percent drop. On a year-over-year basis, exports fell 3.4 percent. The news followed a report from Wednesday that the nation’s industrial production declined 1.8 percent in September. Draghi’s Warning about Germany Rings True The world was beginning to realize that the financial strife which had been afflicting the Eurozone periphery had now impacted the strongest economy of the Eurozone core. The vulnerability of Germany simply underscored the vulnerability of its Euro-core sister, France.
The French National Institute of Statistics and Economic Studies (INSEE) reported that the nation’s GDP has been at exactly zero during the first two quarters of 2012. INSEE will release the third quarter GDP result on November 15. Many economists are anticipating that France’s third quarter GDP will go negative. In fact, several economists believe that France is already in a recession. Obviously, a negative third-quarter GDP result will send EWQ sinking.
On November 9, INSEE reported that France’s manufacturing output declined by 3.2 percent in September after a 2.1 percent increase in August. Output decreased in industry as a whole by 2.7 percent. On a year-over-year basis, manufacturing output decreased by 1.9 percent.
French President François Hollande’s government had forecast 0.3 percent GDP growth for 2012. That will never happen. Worse yet, the Hollande administration anticipates 0.8 percent GDP growth in 2013. Based on this excessive optimism, the French government plans to meet its deficit reduction target with spending cuts of €10 billion and tax increases of €20 billion. As we have heard many times during the discussions of our domestic fiscal cliff crisis, the combination of spending cuts and tax increases during a period of economic weakness is a formula for disaster.
Recent reports from Markit Economics have demonstrated that the business climate in France is awful. Markit’s France Manufacturing PMI for October (released on November 2) indicated a result of 43.7. A PMI below 50 signals contraction. The Markit France Services PMI for October (released on November 6) was even worse. The Final Markit France Services Activity Index dropped to a 12-month low of 44.6 from September’s 45.0. The commentary from the report was particularly gloomy:
French service providers continued to signal a pessimistic outlook in October with regard to business activity over the next 12 months. Although the forecast drop in activity is moderate, the respective index was nevertheless at its lowest level since January 2009. A weak economy and tight client budgets are expected by panellists to weigh on activity.
Jack Kennedy, Senior Economist at Markit and author of the France Services PMI®, said:
“Another weak performance from the French service sector, combined with a further steep fall in manufacturing output, left overall business activity down considerably in October. The pace of contraction in private sector output during the last two months has been the sharpest since the post-Lehmans slump in early 2009. With ebbing confidence having resulted in widespread belt-tightening among clients, the economy heads towards the end of the year on a decidedly precarious footing.”
The economic data produced by INSEE and Markit Economics suggest that there is a significant risk that on November 15, we could learn that the economy of France contracted during the third quarter.
Bottom line: The economic data suggest that France could be reporting a negative third-quarter GDP on November 15. If that happens, it could be a bad day for the iShares MSCI France ETF (NYSEARCA:EWQ).