The following is an excerpt from a Capital Daily report by London-based research provider Capital Economics.

-    The euro-zone emerged from recession in the second quarter

-    UK’s heatwave may have had a mixed effect on retail sales last month (09.30 BST)

-    US manufacturing output may have contracted in July (14.15 BST)

Key Market Themes

Wednesday’s euro-zone GDP data provided a further boost to the region’s stock markets, which have been enjoying something of a revival in the second half of 2013. However, the economic outlook in the euro-zone remains challenging and the debt crisis is far from over (see below). Accordingly, we are sceptical that equities will continue to outperform those in the US despite remaining much more attractively valued. Indeed, we forecast prices to end this year lower than they are now. (See our forthcoming Global Markets Update.)

The total return from euro-zone equities was a paltry 2% in the first half of this year, compared to 14% from US equities. But the tide has shown signs of turning. Since the end of June, the total return from euro-zone equities is 12%, about twice that from US equities.

What’s more, investors are reportedly more optimistic about the prospects for euro-zone equities than at any time since January 2008 according to a monthly fund managers’ poll from Bank of America Merrill Lynch.

We would acknowledge that there is scope for euro-zone equities to continue to outperform US equities based on their relative valuations. After all, the cyclically-adjusted price earnings ratio of the non-financial sector is below 15, some 9 points less than in the US. The last time the gap exceeded 10 points was more than a decade ago, in the aftermath of the bursting of the dot com bubble.

The ratio in the euro-zone itself is also nearly 2 points below its geometric average of the past thirty years, even after the recent rally.

However, the revival in the relative fortunes of euro-zone equities that has stemmed from a shift in asset allocation seemingly owes much to a belief that the region’s economy is firmly on the mend: a net 88% of the Europe-based fund managers that were surveyed by BoAML expect the region’s economy to improve in the next twelve months – the highest reading in nine years.

There is clearly some cause for cheer. After all, output in the euro-zone increased in Q2 for the first quarter in more than a year and a half. However, any further improvement in the euro-zone economy is likely to be less impressive than in the US. And the expansion last quarter masked ongoing contractions in output in the some of the region’s most troubled countries, where growth is sorely needed. As such, we would not be surprised if the debt crisis flared up again at some point in the next few years (although we do not assume such an outcome in our forecasts).

Of course, even if euro-zone equities underperformed US equities again, they might do so amid a broad-based rally. But we expect renewed underperformance to occur in the context of falling, not rising prices. Indeed, with profit margins and valuations in the US stock market looking stretched, we project a decline in the S&P 500 to 1,625 by year-end as the reality of a gradually less accommodative Fed begins to hit home. (John Higgins)

What to watch for today: US

July’s consumer prices release (13.30 BST) is likely to provide further support to the Fed’s view that the downward trend in core inflation was temporary. Energy and food effects were probably neutral last month and our calculations suggest that core prices rose by 0.2% for a third consecutive month. That incorporates a small fall in clothing prices after June’s 0.9% m/m rise, a smaller rise in medical care prices after the big rebound in June and the potential for a leap in tobacco prices linked to tax hikes at the State level. Such a rise in core prices would leave the annual rate at 1.7%, but it would push up the three-month annualised rate to 2.1% leaving it right where the Fed wants it. (Paul Dales)

The latest building permit numbers point to a reversal of June’s sharp fall in housing starts (13.30 BST). The decline in June was partly related to the weather and was also driven by the volatile multi-family sector. Although housing permits also fell in June, at 911,000 they remain above the level of starts. Given that permits have run above starts for three months now, there may be a backlog of projects waiting to get off the ground. As such, we have pencilled in a rise in starts to 925,000 in July, which would be a 10% m/m gain. Meanwhile, the NAHB index (15.00 BST) may have risen to 58 in August, from 57. (Paul Diggle)

The astonishing and largely unexpected improvement in the production index in July’s ISM manufacturing survey leaves it pointing to an almost vertical take-off in output. We would expect to see some turnaround in the months ahead – both the regional Empire State and Philly Fed indices (13.30/15.00 BST) may have fallen slightly in August. We also fear that manufacturing output (14.15 BST) actually contracted in July and gains in the preceding two months could be revised lower. While the manufacturing sector added 9,000 workers last month, average weekly hours worked fell by 0.4% m/m. That meant total hours worked fell by 0.3% m/m. That’s consistent with a 0.2% m/m drop in manufacturing output. The wildcard, as ever in July, is what happened to auto sector output. July retooling shutdowns are rarer now, but it’s not clear whether the seasonal adjustments are keeping up. (Paul Ashworth)

Continental Europe

No major data or events scheduled for today.

The euro-zone GDP figures released on Wednesday confirmed that the currency union emerged from its six-quarter recession in Q2. The aggregate figures showed a quarterly gain in GDP of 0.3%, a bit above the median forecast of 0.2%. Germany’s GDP rose by 0.7%, a touch stronger than expected, and France also surprised with a solid gain of 0.5%. But GDP in the Netherlands fell by 0.2% and we already knew that Spain and Italy had contracted by 0.1% and 0.2% respectively. As such, the peripheral economies remain a long way from the rates of expansion needed to address their deep-seated economic and fiscal problems. The euro-zone’s recession may be over – for now at least – but the debt crisis in the periphery is decidedly not. (Jonathan Loynes)

Japan

No major data or events scheduled for today.

China

No major data or events scheduled for today.

Other Asia-Pacific

After hiking interest rates in June and July, we expect Bank Indonesia (BI) to keep interest rates on hold at its meeting on Thursday as it takes time to assess the impact of recent interest rates increases. However, concerns about high inflation, which reached 8.6% y/y last month, and the weak rupiah have not gone away. The upshot is that we expect to see a further tightening of monetary policy before the end of the year. (Gareth Leather)

India’s latest data releases underline the challenges faced by the country and its new central bank governor. Wholesale price inflation accelerated to 5.8% y/y in July, from 4.9% in the previous month, while consumer price inflation remained high, at 9.6% y/y. Overall, inflation remains a serious obstacle to policy loosening by the Reserve Bank (RBI) at a time when the economy continues to struggle – industrial production released earlier in the week showed a 2.2% y/y decline. (Daniel Martin)

Key Data and Events

Thu 15th      -    Idn  Interest Rate Announcement (Aug)

            09.30  UK   Retail Sales Volumes (Jul)

            13.30  US   Initial Jobless Claims (10th Aug)

            13.30  US   Consumer Prices (Jul)

            13.30  US   Empire State Manufacturing Index (Aug)

            14.00  US   Net Foreign Purchases of US Securities (Jun)

            14.15  US   Industrial Production (Jul)

            14.15  US   Capacity Utilisation (Jul)

            15.00  US   NAHB Housing Market Index (Aug)

            15.00  US   Philly Fed Index (Aug)