Another look at EZ equities

So with earnings season largely behind us, Macro Man thought it might be useful to re-examine his view on European equities.  Although the European earnings season was generally a difficult one, equity indices are nevertheless close to their highs since the August meltdown, even if they remain lower than pre-selloff levels (unlike US indices.)   More  to the point, despite the lousy earnings reports, European stocks are comfortably higher since Macro Man published his bullish scorecard in early September.  Heck, the SX5E has even outperformed the SPX since he suggested as much after last month's ECB meeting.

Macro Man ran the equity screen again, and despite the crummy earnings, the scorecard still loves loves loves European stocks.  (And loathes Brazil.)  Once again, the top of the list is dominated by European indices.


On a pure performance basis, it's interesting to note that many European bourses have trounced US indices in local currency terms, even the Nasdaq.  Of course, in single currency terms it's a different story, with the weakness of the euro eradicating those gains, but fortunately futures investors don't need to worry about that and even real money investors can hedge the FX.

Macro Man will concede, however, that momentum can only carry you so far, and that eventually earnings and the economy will have to either put up or shut up.   To be sure, more ECB QE could put some upward pressure on multiples, which is a good thing for European longs, as well as stoking more lending and economic activity.  As noted previously, we are already seeing signs of this, which should feed through into higher growth and better earnings.

Of course, on a sectoral basis Europe is still stuck in the 20th century.  That earnings track industrial production as closely as they do is telling; one can envisage corporate America snickering to itself and asking Europe, "wait,  you actually make things???"  Indeed it does; even if we broaden to the Stoxx 600, we see a very close relationship with IP.

Without an upturn in European industrial production, therefore, it is difficult to envisage a sharp rally in earnings, and the bull case rests solely on the ephemeral delights of multiple expansion.  (As an aside, it's difficult to know what to make of the constant over-estimation of earnings.  Is it stupid analysts or dodgy Bloomberg data?  If the latter, the same phenomenon also afflicts estimate data for the Eurostoxx-30 and MSCI indices as well.)

That MFI lending across the Eurozone has turned up is a good sign, and erstwhile pockets of weakness are already doing quite well; did you know that Spanish GDP has risen 3.4% y/y through Q3?  Things can generally turn quite quickly once sentiment improves; just look at Australia, where the unemployment rate was at 13 year highs in July and is now at its lowest level since the spring of 2014.

On a secular basis, it is difficult to be enthused about European outperformance given that so much market cap is devoted to industrials and financials, neither of whose long-term growth prospects look great.  Over more intermediate time frames, however, the chances for upside surprise look solid, and so Macro Man sticks with his view.

Speaking of sudden turnarounds, the newsflow from China has turned abruptly (if only briefly!)   When Macro Man updated his real-time China growth indicator after recent data releases, he was bemused to see it slip below 6%.  He'd be lying if he said it wasn't a concern; the economy cannot decelerate forever and still muddle through.

That being said, the recent "Singles day" shopping extravaganza was beyond a blockbuster.  Alibaba notched more that $14 billion worth of sales yesterday; to put that in perspective, in the entirety of Q4 last year- holiday season in the West, and then some- Amazon registered $29 billion of sales.  It will be interesting to see how this shows up in the retail sales for this month, especially as consumption has been one of the few bright spots in the economy.

Perhaps it's a coincidence, but Macro Man's observed that Taiwan and China are two of the top four EM markets in the scorecard now.   Hmmm......
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GlobalTrader
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November 12, 2015 at 8:40 AM ×

Brazilian stocks are at 11 PE, 4.5% yield and 1.1 book value. Now maybe you dont like the FX risk but that's a problem of the exchange rate, not the stock market. I'm not sure why you don't like Brazilian stocks, you are supposed to buy when there is a crisis

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Anonymous
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November 12, 2015 at 10:32 AM ×

The Aussie jobs data was undeniably good, even if you take out the sample rotation effect which probably accounted for around 30k. The problem, as with the UK and US, is that the type of jobs being created are low paying. 1 mining salary in Australia is approximately the equivalent of 4 service sector salaries. There should be no surprise that wage inflation is non-existent anywhere.

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Booger
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November 12, 2015 at 12:08 PM ×

The Aussie jobs data is interesting and one wonders how they keep chugging away. I suspect it is a tailwind from the real estate bubble from Chinese capital flows. It may have ended or may end soon.

I think a paired long usd.cnh and short aud.usd position is a high probability long term bet and initiated such a position today. The interest rate cuts over the last year are driving China closer everyday to breaking the RMB/$ peg or imposing very strict capital controls. They cannot move interest rates down and not expect profound pressure on the peg. This leaves only two options: float the RMB or impose strict capital controls. So far China seems to have a fuzzy soft policy on both accounts. They appear to be quietly but gentling tightening capital controls and while they are using large amounts of capital to defend the RMB
...Lowering interest rates is the right policy and in fact, they probably should be lower. PPI is nearly negative 6% and CPI is under at 1.6%. With interest rates above 4% and borrowers mostly paying above 6%, corporate real rates are at 12%. There is no reason interest rates should be so high except to maintain the peg. It is illogical that they are strangling the economy to maintain exchange rate stability.

If they allow the peg to float, usd.cny will benefit. If they instead impose strict capital controls, this will choke off capital inflow to Australia and the real estate bubble, short aud.usd will benefit.

That is without a U.S rate hike or ECB action, either of which will put further enormous pressure on the Chinese.

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Bruce in Tennessee
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November 12, 2015 at 12:49 PM ×

http://www.reuters.com/article/2015/11/11/us-china-trade-idUSKCN0T02LB20151111

But the terms of China’s membership stated that – because it was not a “market economy” – other countries did not need to use China’s domestic prices to justify their accusations of Chinese dumping, but could use other arguments. China’s representative at a WTO meeting on Tuesday said the practice was “outdated, unfair and discriminatory” and under its membership terms, it would automatically be treated as a “market economy” after 15 years, which meant Dec. 11, 2016. All WTO members would have to stop using their own calculations from that date, said the Chinese envoy. Dumping complaints are a frequent cause of trade disputes at the WTO, and dumping duties are even more frequently levied on Chinese products.


...If this article is anywhere close to correct, it seems to me that this will add to deflationary pressures after December 2016....interesting read...

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abee crombie
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November 12, 2015 at 1:41 PM ×

Booger, I like your thinking. Regarding why Chinese wont lower rates, its very simple, bc banks need to make their 2- or 3% (I forget the numbers off the top of my head) Net Interest Margin. Deposit rates are already at 1.5%, I think the chinese have signaled they wont lower again into 2016 and I dont think they are in a position just yet where they need to get to 0 rates like US and EU, but lets see. However, I think we are going to bounce in AUD and CAD here as long as stock markets dont swoon again. I woundnt be surprised to see aud go back to 0.75. For my money, EUR is my only short and I'm bullish MXN as I expect US PMI to go back up (and if I am wrong, tight stop and get ready for a big trade somewhere else bc we are screwed!)

MM, yes its all about earnings! SXXP (stoxx 600) has seen rising eps projections since Q1-13, with higher highs and higher lows. To me that is a trend ;-) Its probably right to stay with it given the liquidity conditions and tailwind of ECB actions. However stock markets are struggling to get back above 200 day, including my "to watch" sector, Industrials. I'm thinking of buying calls

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Anonymous
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November 12, 2015 at 1:44 PM ×

Huge riots in Greece today, massive anti-EU crowds taking to the streets. Portugal has also just formed a communist/socialist anti-EU government. Sweden is closing it's borders in contravention of EU laws, several other countries following. Huge anti-immigration sentiment in Germany threatens to send them to a tipping point soon.

Expect an implosion of the EU next year and EU politicians and central bankers to be sent to prison for crimes against Europe's citizens. Iceland have done just that, and it's likely we see a similar model follow in Europe - at least let's hope so.

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abee crombie
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November 12, 2015 at 2:50 PM ×

Thanks Anon 1:44, perhaps I am missing that.. something does feel a little amiss. Copper and other metals at lows or new lows, oil looking heavy as well. EM FX right near breaking point and HY spreads have been widening over the past few days. Certainly these assets have to stop going down in order for equities to rally. But so far selling doenst look like it has heavy volume

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Anonymous
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November 12, 2015 at 3:34 PM ×

Into the infinite unknown...

*IMF REITERATES LENDING-INTO-ARREARS POLICY TO BE DISCUSSED SOON ( cheers erupt across Greece !!! here comes MORE bailout loot )

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Anonymous
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November 12, 2015 at 3:38 PM ×

BBG: Deutsche Bank suggests #ECB may never lift deposit rate above 0.

No kidding.

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Nico G
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November 12, 2015 at 3:39 PM ×

Anon 1:44

Amen - the Brussels colonels need to be hung 'haut et court'

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Leftback
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November 12, 2015 at 4:05 PM ×

Never is a long time... inflation will make a comeback after the issue of very low rate perpetual bonds...

It does feel as if something wicked this way comes. Can't put my finger on it, but agree that China has been the epicenter of volatility this year and will probably be so again the next time vol breaks out, which it seems likely to do soon.

Agree with Global Trader on Brazil, as few names have already bottomed out, will keep an eye on the stocks we are holding, but for the time being wary to add b/c of the certainty of Brazil being in the Tax Loss wheelbarrow that is about to get dumped out on the compost heap in the next few weeks. We will await all the toys being tossed out of the pram.

LB's recent rates punt is in the green at the moment. The twin danger from hot US economic data points and Fed jawboning seems to have passed for the time being in the wake of last Friday's screaming hot NFP number.

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abee crombie
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November 12, 2015 at 5:22 PM ×

heads up on Brasil. The banks are playing games. They were forced to take higher provisions this quarter but somehow found the extra money by reduced taxes. Until NPLs formations slow down I'd be cautious. If conditions deteriorate any more than they have planned, its gonna get ugly. I'm not saying it will, not even my base case, but just a heads up. And even then, banks aren't earning more than thier crazy high cost of capital. Why buy stocks, just buy the FX and collect carry

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Hugo Ferrer
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November 12, 2015 at 6:24 PM ×

M1 leads industrial production https://twitter.com/ContraInvest/status/664870437109788672

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Nico G
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November 12, 2015 at 8:01 PM ×

abee everyone is playing games in Brazil they manage companies like they play football you know, with the occasional referee bribe

after last visit the long is squared and i'll wait for a horrible capitulation to get in, not comfortable otherwise. If US equities sell off like i expect i do not think folks will pour into EM equities just yet there ought to be a worldwide, correlation-1 move out of equities

Europe is the big outsider and the short there not very comfortable for now

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Anonymous
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November 12, 2015 at 8:42 PM ×

EM debt increasing fr 150% to 175% per latest Economist

No problem.

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Leftback
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November 12, 2015 at 9:54 PM ×

Equities looking as though they will sell off on almost any excuse tomorrow. We are long a modest amount of TLT and AGG today at the Hammock, as well as TLT calls. US inflation and retail data up next, with crude oil likely to continue its slide on many signs of over-supply. The data are unlikely to be "Scorchio", more likely "Snoozio" or even "Glacio". It's a flat world out there just at the moment as Dr Copper is telling us - he is still unable to locate his own Bottom.

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hipper
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November 12, 2015 at 10:09 PM ×

Perhaps the EZ credit growth was due to a bounce and it's reasonable to assume that it will run a bit further from here. But without pre-GFC extra-EU export growth support at the same time it might be plausible to assume that the credit bounce will not be able to sustain itself too far regardless of QE. EZ equities probably should still remain a P/E range game with continuous lack of revenue growth and with the low hanging fruit of cost cutting already mostly consumed. But either way seasonality (santa rally and the combined spring dividend mania) should still support here, so at least there's a reasonable chance to outperform peers. The obvious risk to Santa rally would be Yellen flipping and actually considering that added TLT. GDX makes one wonder whether it's constructing a rather strong bottom at 13? Even if the Fed doesn't flip, with the "one-and-done" having a high probability that bottom would still fit the narrative.

Yeah commodities are really looking terrible: i.e. iron ore, copper and friends. The only strategy there seems to be to lower costs through increased mining in the hope to drive competitors out. It's really a strategy with a lot of self-inflicted wounds in the process for Big Commodity but of course they might still be correct in saying there is really no better alternative. The pre-GFC suction from China is still nowhere in the horizon.

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Anonymous
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November 12, 2015 at 11:19 PM ×

I havent looked at equities in the last few hours, but i felt a dax pasting was coming. A bit of a euro pullback too. Ftse broke a big level. Dax usially follows. Momentum has failed after significant rally.

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Cityhunter
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November 13, 2015 at 12:29 AM ×

Price action reflects the major force of the market, and cheap things could get much cheaper. DAX just started to correct lagging behind SPX, but they all have a long way to go down from here...until Yellen changes her mind and mouth again.

Regarding Chinese 'single day' shopping figure, the actual realized sale should be much smaller. First, there is significant sudden price marked up just before the 'single' day so the sale is not a bargain, and Chinese people love to order much more than they would eventually pay for the sake of having more choices. A big chunk of the 'single day' sale will be canceled in the coming days.

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Anonymous
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November 13, 2015 at 3:02 AM ×

@cityhunter,

What you said on China's single day might be true, but it is hardly the point. The point is that the biggest one day sale is likely to reduce the future consumer demand: many people bought several months' houseold supplies and big ticket appliances in one day. There was not much extra consumer demand from single day event.

I mentioned on this blog's comment area a few days ago, my bet is on PBOC making another move by the end of the year. That is a big risk along with Fed lifting rates.

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abee crombie
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November 13, 2015 at 3:49 AM ×

Meanwhile back in single stock land, inside the equity markets, the laggards are getting flushed down the toilet (again), CSCO and JWN getting beaten up after hours after bad results (the retailers are just getting pounded here) yet the narrow list of companies beating and doing well are holding up. (GE, MSFT, GOOGL, FB, AMZN) at some point you would think amazon has to sell off given the carnage of what is happening in retail. I think but i'm not betting on it. Either way the there needs to be a big rotation soon (IMO the turds need to find a bid by tuesday) otherwise i see a big move. I am bullish here but retain the right to switch.

Tomorrow will likely be ugly

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