Some of Europe's economic vital signs appear worse now than in March 2012, when Greece defaulted on its sovereign debt. Productivity growth during 2015 fell to 0.8% per year from a persistently low level (average of 1.8% from 2010 to 2012). Policy uncertainty in June 2016, according to one well-known academic measure, increased relative to the 2010-2012 average by nearly a factor of two. Growth and unemployment have improved slightly but remain depressed, and expectations remain low.
Asset allocators might not want to rely on policymakers to nurse the economy back to health, at least in the near term. Average “fiscal space,” a metric that tries to quantify European governments' balance sheet fitness, has deteriorated in the EU since 2012 (see Figure 1). If this trend continues, policymakers might have limited resources to stimulate the economy and to absorb future financial shocks. As a result, the market might expect higher credit default risks that further stress Europe's economic health, creating a deteriorating cycle. Brexit represents an additional symptom, and its sudden appearance makes Europe's health issues appear more acute. However, Europe's sickliness extends well beyond the U.K.'s vote to leave the European Union.