Is it Time for European Equities?
In a previous post titled, Is it time for Global Equities? , we highlighted some of the trends in the international equity markets from a valuation perspective, as well as some indications of a reversal in the Euro. Since this post we have seen a continuation of the Euro rally and compelling action in international equity and fixed income markets relative to their U.S. based counterparts.
2016 headlines have been dominated by the excessive equity volatility on both sides of the pond, but the stealth champion of the year so far has been international bonds. With all indications pointing to persistent lower interest rates globally combined with tailwinds from a weakening U.S. dollar, international bonds have handily outperformed other major asset classes as depicted in the table below:
Emerging markets are also off to a great start as the commodity complex has rebounded substantially. Valuations remain near historic lows relative to U.S. equities and there would appear to be a long-term opportunity at these levels. The Eurozone generally and Germany in particular continue to trade at steep discounts relative to their U.S. based counterparts as illustrated below:
When we last spoke of the Eurodollar, we were in the midst of a rather sizable rally on the back of a lower-than-expected rate cut by the European Central Bank (ECB). As described in the chart below, the Euro closed up over 3.00% on the day and we tossed around the ideas that (1) this was indicative of a bottom with strong support at the $1.05 level and (2) that there are few options remaining for the ECB to weaken the currency. This morning further confirmation was received as the ECB left rates unchanged; the Euro traded slightly higher against major currencies following this announcement:
A look at the broader U.S. Dollar index confirms that the strength could be coming to an end. After a spectacular rally in 2014 adding 12.8% the index has been range bound fluctuating between roughly 93.00 and 100.00. A break below 93.00 would signal a continuation of dollar weakness and would bolster the case for international markets:
Caution Ahead for U.S. Equities
A U.S. Dollar move to the downside could be seen as an indication that economic growth is not as strong as equities would imply. As prices quickly approach all-time highs, forward looking P/E measures for the S&P 500 have cruised beyond their 2007 peaks. Earnings for Q1 2016 are projected to be down 9% YoY and Economic data has been coming in a bit softer than forecasted. Should this trend continue it may boost speculation that the Fed backs away from its current plan for multiple rate hikes this year further pressuring the U.S. Dollar to the downside.
On the bright side most investors should be naturally overweight the U.S. markets in their portfolios given the massive outperformance over the last 5 years. The confluence of trends point to an opportunity to begin diversifying into the international markets.
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