EZ and US

A slew of Chinese data was released Sunday evening, and at first glance there isn't a whole lot in it.  Y/Y GDP growth beat expectations slightly (thanks to a small upward revision of Q2 data), as did retail sales, while IP disappointed somewhat, registering its joint second-lowest reading of the past two decades.  That AUD/USD was utterly unchanged five minutes after the data probably tells you what you need to know in terms of the market's initial read on the numbers.  Unfortunately for the five-minute-macro crowd, the story in China is likely to remain one of evolution rather than revolution.

It's been a few weeks, so Macro Man decided to re-run his global equity screen scorecard over the weekend.     Readers may recall that the last time he ran it, the analysis generally loved European equities and hated Brazil.   So it perhaps comes as little surprise that when he re-ran on Sunday, the scorecard.....loved European equities and hated Brazil.  It wouldn't be very macro if it changed a lot in the span of a few weeks, now would it?


For the past few weeks/months, Macro Man (and a few commenters) have expressed some preference for Eurozone equities over their US counterparts.   Perhaps it's a vaguely uneasy feeling that the US bull market is long in the tooth.   Perhaps it's a sneaky suspicion that the EZ credit impulse is picking up, and with it the prospects for a decent rebound in European nominal GDP growth.  Perhaps it's a comment on the likely relative monetary trajectories of the two economies.  Or maybe it's a combination of all of these, with a few other factors sprinkled in as well.

What's undeniable, however, it the strong and sustained outperformance of US equities over their European counterparts since the crisis.  The chart below plots the ratio of the SX5E total return index over its SPX counterpart.
 

Of course, US equities didn't have to face bone-headed rate hikes like those in the Eurozone in 2008 and 2011.   (Cue cries from the peanut gallery that Macro Man is now advocating a bone-headed rate hike in the US!)  Still...it's a pretty astonishing outperformance by the US, which has basically doubled the total return of the Eurostoxx this millennium.

Some of this is undoubtedly due to the compositions of the respective indices.  Financials have a substantially higher weight in the Eurostoxx  (both 50- and 600-member versions) than in the SPX, and European financials haven't exactly been a safe harbor during and after the financial crisis, which has dragged down the overall performance of the index.

Still, it's not like the European economy has delivered the goods, either.  Unsurprisingly, there is a very good relationship between trends in European industrial production and earnings expectations/dividend payouts.   Although the relationship between relative IP and relative equity performance is somewhat less strong,there's clearly some correlation.





Still, it's notable that the rebound in Eurozone earnings has lagged where it "should be" given the bounce in IP.  (In contrast, US earnings are higher than they "should be" relative to IP.)  This no doubt says a lot about finance: the ongoing travails of the Eurozone banking system (viz. DB last week) versus the financial engineering prowess of US corporates. 

Obviously, there's more to the historical relative performance of the two equity markets than that, but in taking a view on Europe it's important to know where one stands.   To favor EZ stocks over their US counterparts, you have to be willing to bet that:

1) EZ nominal growth, or at least the second derivative , will outperform its US counterpart

2) EZ banks will go from an anchor to a source of outperformance

3) The US issue 'n' buyback game will slow if not halt

4) Europe is simply more compelling when viewed from a value prism (with a reasonable degree of confidence that it is not a value trap!)

Of these, Macro Man's thesis rests largely on 1 (an upturn in Europe, which admittedly looks slightly less convincing than a few months ago) and 4.  Factor 3 is more of a wish than an expectation, and as for Factor 2....well, let's just say he'll believe it when he sees it.
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Anonymous
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October 19, 2015 at 8:58 AM ×

I'm one of the commenters who is of the same view. I think you most of the points covered though i have to say for me ecb qe extension is also a consideration..the discount factors by pushing long dated yields is also a positive in my view.Moreover, Eu earnings margins have room to expand.
one thing against may be positioning which i thought had reduced substantially last quarter but according to Boa.ml survey ez still looks preferred region
I also have compelling reasons to be short US markets and feel this trade might work in up and down markets ( as hard as it is to believe that eu has a smaller beta on the downside!)
short term
no one expects ecb to move in oct but that might be the biggest bang for their buck( thinking BOJ last fall)
spy up 3 weeks in a row, but below 200d, short on close has good risk reward

no a separate note, given shortage of assets to buy in ecb qe program, can ecb buy equities in their mandate? i actually don't know and no its not wishful thinking but a serious inquiry.





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rp
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October 19, 2015 at 9:18 AM ×

Mainly 4 with a dash of 2, but 1 seems v. optimistic. Also as above, the prospect of further QE support. If we are dealing in the realms of 1 being a possibility then I don't see why the end of austerity / tight FP programmes couldn't be brought forward a few years.

With US equities I would need to bank on selling to bigger fools (...although here's a few...)
http://fusion.net/story/212754/meet-the-teens-who-cant-wait-to-become-hedge-fund-managers/

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Booger
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October 19, 2015 at 12:15 PM ×

Not surprisingly, the Chinese data was 'just right'. Not too soft to freak anyone out and soft enough to justify more easing. Cutting the RRR and interest rates I presume (again) and this might cause a further rally in EM for a few hours. The Chinese need to ease further to stimulate, but the more they do this, the more capital flight there will be without cutting the Yuan peg.

Brazil continues to implode and that silly 50% rally in petrobas is being given back. My wild guess for the next EM step is: China cuts rates, Brazil blows up, triggering faster EM capital flight and eventually a yuan cut in November. I think the end of the week or next week is looking like a good place to start looking at EM FX and comm-bloc shorts. Particularly AU: it looks like the market is challenging the RBA. They will be pressured to come out with more explicit talk on another rate cut if AU continues to rally to 0.75 or above.

I was looking at an article on the long term fundamentals of oil and it doesn't look that great. The best long term commodity investment might be to go long ags when oil bottoms out the current commodity bear market. At some stage ags will diverge from hard commodities one would suppose.

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Anonymous
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October 19, 2015 at 1:04 PM ×

Interesting.
"We met with many clients in the US, Europe and Asia. The wall of bearishness was extreme in the US – roughly 80% of meetings "
FTAlpha piece.
Historically, it's not typical to get major down moves when bearish attitudes are so extreme. You might still get a low volume drop, but bearish positioning would suggest such a drop would get bought sooner than later. My view ,if you don't want to be long then neither would I want to be short with not enough to make it worth my while.

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washedup
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October 19, 2015 at 1:14 PM ×

MM - no disagreements with the broad ideas of course - just wanted to point out that the elephant in the room regarding european equities vs their US counterparts isn't as much underperforming financials, but the lack of outperforming technology. There simply aren't sexy tech names in europe that get people to take flights of fancy on multiples - it would be useful to check how much of the multiple outperformance of US equities is simply due to that.
Its a low risk, low reward game to be long europe. Of course that sounds far better than the high risk, low reward game that is US equities!

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Nick
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October 19, 2015 at 1:51 PM ×

Ags are different from other commodity classes due to weather factor.
That said modern technologies: GMO, precision agriculture, farm management software mitigates all but the most severe weather impact.
For example the rain makes grain but this spring / early summer there was too much rain in the US. Looking at analog years one would expect lower yields due to late planting, shallower roots, nitrogen loss. As it turned out beans have the second highest yield on record and corn is doing just about fine.

Bearing extreme weather event (which will come at some point, could be as early as next season in case of La Nina) agriculture is mostly influenced by energy and EM currencies.

Energy, biofuels used to drive marginal demand in corn and in soybeans to some extent (much less of an impact with relentless growth of palm oil production). Persistent uncertainty around Environmental Protection Agency Renewable Fuels Standards and falling crude prices removed this tailwind.

Weakness in EM currencies: BRL, UAH, MYR, ARS (bule dollar) created a headwind of lower production costs vs. US.

All of this makes US agriculture loss making with the current levels of land rents.

The land rents are likely to decrease somewhat this marketing year, but without weakening USD, supply is not just about to fall yet.

The farmer is not an eager seller at the current levels, hence we are locked in a range until something changes, be it energy, FX or weather.



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Anonymous
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October 19, 2015 at 1:59 PM ×

https://twitter.com/tracyalloway/status/656040672298954753/photo/1

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washedup
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October 19, 2015 at 2:54 PM ×

Indeed anon - we have been witnessing a large scale, slow motion LBO of the US equity markets ultimately funded by EM (especially Chinese) central banks since the early 2000s.
Wanna guess the lowest common denominator that made it all possible? The commodity bubble.

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Eddie
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October 19, 2015 at 3:22 PM ×

Re China Growth:

"But in nominal terms, it grew just 6.2%, the slowest top-line growth for the economy since 1999. ... The reason the real GDP figure came in higher than nominal GDP is that the “deflator” that Beijing’s statisticians applied was negative for the second time this year. It was also negative in the first quarter. "

http://www.wsj.com/articles/china-gdp-deflategate-comes-to-beijing-1445236431

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Leftback
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October 19, 2015 at 3:52 PM ×

Yes, agree on EZ>US, and mainly b/c of 4) value, although a nod to an accelerated ECB QE program might spur another wave of spread compression in EU fixed income that would greatly benefit 2) the banks, which are stuffed to the gills with peripheral sovereign bonds and corporate debt, and that might lead to a bit of 1) recovery.

I do agree with the view above that another yuan devaluation is out there on the horizon, only this time it is only an ugly little grey duck, not a Black Swan, as we have seen it before. Right now we seem to be entering a little period of USD strength as Bucky retraces some of his recent fall from grace, and these weeks have proved to be a poor time to be long risk.

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Mr. T
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October 19, 2015 at 6:24 PM ×

I think EZ equities are in a no mans land, would rather have exposure to sectors with good newsflow in HSI or NKY than buy the EZ bloat. washed @ 1:14 shares my feelings - the lack of breakout growth names limits the attractiveness and you are left with some "relative to NIRP" value but little else. Heres a fun little screen for regions={US,Europe}, cap > $25BUSD, 5 year revenue CAGR >= 15%. Not a lot of EZ there.







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lol
admin
October 19, 2015 at 7:12 PM ×

http://www.zerohedge.com/news/2015-10-19/deutsche-bank-junior-trader-mistakenly-paid-hedge-fund-6-billion-fat-finger-error

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abee crombie
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October 19, 2015 at 10:46 PM ×

Mr T and washed, I think you guys hit the point exactly, the reason EZ equities indicies suck is bc the underlying companies suck. I did a quick compare of FEZ with SPY performance since 2011 and here is what you get. A total of 45% point underperformance in FEZ, 16.5% in Technology, 6.8% in Consumer Discretionary (now that autos are in the dumps) 6% in health, 5.7% in Industrails etc

Also when you look at the indexes based on factors like growth or value, you will see large differences. This again only goes to highlight how bifurcated the current stock market is. Lots of stocks in the crapper, and yet FB and AMZN making new highs.

Nick on your aggs, check out Sugar. its moving on El Nino fears

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October 19, 2015 at 11:28 PM ×

I have to agree. Both this post and your comment made my morning :-)

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Expensive stuff only
admin
October 20, 2015 at 3:27 AM ×

Hi Johnny, I dont like expensive low quality goods, otherwise known as crap.

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