Do Euro Zone Stocks Signal Euro Deflation?

Mary-Lynn Cesar, Kapitall: The European Central Bank believes the euro zone will avoid deflation. Do sales ratios of euro zone stocks disagree?

The euro zone economy ended 2013 on an upswing as it grew for its third consecutive quarter according to the latest data from statistics agency Eurostat. In the quarter ending December 31st, the GDP of the then 17-member currency union (the newest member Latvia joined in January) grew by 0.3%, up from 0.1% in the previous period. For 2013 overall, GDP fell 0.4% from 2012.

Read more from Kapitall: Hedge Funds Are Buying 8 Retail Stocks as Consumer Sentiment Holds Steady

Better-than-expected economic expansion in France and Germany drove last quarter’s growth. Germany’s economy grew by 0.4%, buoyed by increased exports and capital investments, resulting in a 0.4% GDP increase for the entire year. In France, the INSEE agency reported that GDP rose by 0.3% in the fourth quarter as well as over the course of 2013.

Limited Growth and Contractions

The troubled economies of Italy, Portugal, and Spain grew modestly during the quarter. Italy’s GDP rose by 0.1%, the first instance of economic recovery in the euro zone’s third largest economy since 2011. Spain’s GDP grew for the second consecutive quarter, rising 0.3%. Portugal led the group with a 0.5% increase. Further north, a 0.7% expansion led the Netherlands to its second straight quarter of growth following a year-long recession.

Meanwhile, Cyprus, Estonia, Finland, and Greece all reported contractions. Cyprus’s economy shrank by -1.0%, Estonia’s fell by -0.1%, and Finland’s contracted by -0.8%. Greece’s GDP also declined, but Reuters reports that the nation’s -2.6% fall was its smallest since the second quarter of 2010 on an annual basis.

Deflation Worries

At the beginning of February, the European Central Bank (ECB) decided to keep its benchmark interest rate at 0.25%. This marks the third straight month of the record low rate, which was chosen by the ECB to combat low inflation and spur the economy. The latest decision to hold steady follows January’s economic data, which showed that inflation in the euro zone fell to a four-year low of 0.7%. For context, the ECB’s target inflation rate is “below, but close to 2%.”

Last month’s drop in inflation has many observers — from The New York Times Editorial Board to Reuters poll participants — concerned that the euro zone is approaching Japanese-style deflation, a sustained, broad decline in prices of goods and services. Deflation causes a "vicious circle" in economies when people spend less as they wait for the value of their money to fall even further. The burden of debt rises, and companies’ profits diminish as they see less revenue. Companies then have to cut their expenses, and they do this by reducing wages, laying off workers, and enacting other cost-saving measures.

These worries were compounded by the ECB’s decision to keep the interest rate as is and not add stimulus. Mario Draghi, the central bank’s president, dismissed the deflation talk, stating, “There is certainly going to be subdued inflation, low inflation for an extended, protracted period of time, but no deflation.” He also said that the ECB needed to review additional data, including last week’s GDP report, before it reassessed its monetary policy in March.

Mounting concern over deflation inspired us to take a closer look at the sales trends of euro zone stocks. We specifically looked for stocks experiencing slower growth in revenue than inventory over the last year as well as inventory growing as a portion of current assets over the same time period. Inventory, the portion of goods not yet sold, is a sales metric. Firms that satisfy the aforementioned conditions are experiencing negative sales growth, and that is a discouraging sign.

Click on the interactive chart below to see sales data over time.

Do you think the inventory issues of these euro zone stocks are tied to the currency union's inflation struggles? Use this list as a starting point for your own analysis.

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