US Stocks On Verge Of Reasserting Their Dominance Over EU
Authored by Simon White, Bloomberg macro strategist,
US stocks are poised to outperform their European peers as recession risks in Europe look underpriced.
Like a pendulum, sentiment in markets has a tendency to swing from one extreme to another. It was barely a year ago that the prevailing narrative was a Europe on the verge of an energy-driven existential crisis. The seriousness of the predicament concentrated minds wonderfully, and Europe has so far managed to dodge the most doom-laden predictions.
But the pendulum has swung back too far. The narrative has transformed into a Europe that will avoid a recession, or much of a downturn, altogether. Yet the data tell a different story.
Leading economic data is the most pivotal for markets, which are (or should be) forward-looking mechanisms.
I’ve combined such data into an indicator that leads European growth by about six months. It paints an unequivocally downbeat picture.
So where is the optimism coming from? Most of the reason for cheer in Europe is due to bounces in PMIs, with the Spanish and Italian manufacturing surveys now back in expansionary territory. Also economic sentiment, compiled by the European Commission, has risen, while the ZEW’s expectations of economic growth has bounced hard. Consumer confidence is higher as well.
But recoveries in soft, survey-based data when not accompanied by a similar improvement in hard data are paper thin, and can quickly be reversed. That is where we are with Europe.
Since last summer, economic surprises have been driven by soft data. It is the rise in surprises that has helped propel European equities to their best outperformance of US stocks in almost twenty years.
Labor data have stayed supported, but other hard data such as retail sales, factory orders and industrial production remain weak. Most egregious is the largest fall in real M1 growth on record, surpassing a level that has preceded the last two European recessions.
Some have argued that M1 has lost its forecasting power as higher rates have made overnight deposits less attractive than longer-term ones. But the latter are counter-cyclical, while overnight deposits (whose drop is driving M1’s fall) exhibit a clear relationship with future activity. Ignore the collapse in M1 growth at your peril.
There was a good case to be made for European equity outperformance last year. The market was oversold and underowned, sentiment was very negative and equity returns were broad based. None of those is true today.
After a 30% rally off the October lows, the market is looking overbought. The move higher is now being driven only by revenues, unlike last year when these, along with margins and dividends were all contributing to returns.
US stocks, on the other hand, are beginning to look relatively attractive. Despite a roster of reasons to be skeptical about the resilience of the US market – recession risk, instabilities from zero-day option trading, negative gamma, overvaluation - some technicals are becoming constructive.
The beauty of those is that they are pure - aloof from commentary, opinion or the economy - driven only by price and volume. They may sometimes go against your “common sense” view, but when a weight of them point in one direction, it’s often prudent to drop your current narrative and follow the price.
Of most note is the change in the S&P’s trend this year. One of the simplest and most reliable measures of the stock-market’s medium-term trend is the 13-week versus 26-week moving-average crossover. Very simply, the market is in a downtrend when the 13-week is below the 26-week, and vice-versa.
The 13-week moving average went back above the 26-week about 5-6 weeks ago, suggesting the current upward trend in US stocks could be maintained for several more weeks at least, perhaps much longer.
On top of that, other technicals, such as advancing versus declining issues, number of stocks making new 52-week highs, and the percentage of stocks trading above their 200-day moving average are all constructive for higher prices, with none indicative of extremely overbought behavior that can precede a larger correction.
The Fed is most likely closer to the end of its series of hikes than the ECB. Indeed, the ECB risks amplifying the weakness in the economy that hard data betrays, as it becomes more gung-ho in its hawkishness, emboldened by resilient soft data and sticky inflation.
Europe has had a good run, but the summer tends to be a graveyard for outperformance versus US stocks, with May to September showing a consistently negative trend. Even more, the US on average outperforms global stocks May through November.
It is said life is like a pendulum: the deeper the sorrow, the greater the joy. After several months of sorrow, US stocks may soon be about to experience the joy of pre-eminence once more.