Correlation at 2008 Low Leaves European Stocks Trailing
Euro-region stocks are missing this year’s global rally as four years of lockstep moves in markets break down amid diverging outlooks for economic growth.
Correlation between the Euro Stoxx 50 (SX5E) Index and the MSCI All-Country (MXWD) World Index of 45 developed and emerging markets has fallen to 77 percent, the lowest level since the collapse of Lehman Brothers Holdings Inc. in 2008, according to data compiled by Bloomberg. The European gauge has dropped 0.2 percent in 2013, hurt most by utilities Iberdrola SA (IBE) and RWE AG. (RWE) Benchmark equity indexes in the U.S., U.K., Japan, Switzerland, Sweden and Australia gained an average 8.5 percent.
While bonds of Europe’s most indebted nations lead global debt markets and the euro strengthens as concerns about a breakup of the single currency evaporate, the region’s stocks reflect economies in a fifth straight quarterly contraction. Investors should sell euro-area equities as European Central Bank support shrinks while elections in Italy may derail austerity efforts, according to Fidelity Worldwide Investment and Pictet & Cie.
“The outlook for European equities is discouraging,” Supriya Menon, who helps oversee $408 billion as a multi-asset strategist at Pictet in Geneva and favors Japanese shares, said in a phone interview on Feb. 21. “Stock valuations are high, earnings forecasts are overly optimistic and the European Central Bank is beginning to reduce its balance sheet.”
The 120-day correlation between the Euro Stoxx 50 and the MSCI All-Country has fallen from a near-record 90 percent in April 2012. The relationship averaged 86 percent from 2009 through 2012, data compiled by Bloomberg show. A reading of 100 percent would indicate moves are in lockstep, while minus 100 percent would show they always move in opposite directions.
While the gauge of stocks in the 17-nation euro area rose 0.6 percent last week, it’s off to the worst start to a year since 2008 compared with the rest of the world. Shares fell as Italy’s former Prime Minister Silvio Berlusconi, who presided over a slump in government bonds that sent yields to a euro-era record in November 2011, seeks a comeback in today’s elections.
The Euro Stoxx 50 gained 0.8 percent at the close of trading, while the Standard & Poor’s 500 Index slipped 0.4 percent as of 11:56 a.m. in New York.
The MSCI All-Country gauge slipped 0.5 percent last week, trimming its 2013 advance to 4.1 percent. The measure has surged 105 percent since dropping to a six-year low in March 2009 as policy makers from Washington to Frankfurt to Tokyo bought unprecedented amounts of bonds to revive their economies. The Federal Reserve has injected more than $2.3 trillion into the financial system, and the Bank of Japan is providing over $800 billion of support.
The ECB flooded markets with about 1 trillion euros ($1.3 trillion) of three-month loans via so-called Longer-Term Refinancing Operations, or LTROs, last year, helping spur a 14 percent gain in the Euro Stoxx 50.
While the Fed and BOJ are continuing to add liquidity to their economies, ECB funds are already being drained from Europe’s financial system. Banks will have repaid 212.3 billion euros of the emergency cash by Feb. 27, according to figures last week from the Frankfurt-based ECB.
“The countries that have been doing more monetary easing have seen better equity performance,” Juan Nevado, who helps manage $330 billion at M&G Investments in London, said in an interview on Feb. 20. “Euro strength and LTRO repayments are effectively a tightening of monetary policy.”
Even as euro-area equities have fallen this year, the region’s currency and the bonds of its most indebted nations have rallied. Greece’s debt returned 7.4 percent through Feb. 21, for the best performance among indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Spanish bonds gained 2.2 percent as the IBEX 35 (IBEX) gauge of equities fell 1.9 percent. Italy’s notes climbed 0.6 percent, compared with a 1.6 percent drop in the FTSE MIB stocks index.
The euro appreciated 2 percent through Feb. 22, the third- biggest gain among 10 developed-market currencies, according to Bloomberg Correlation-Weighted Currency Indexes. It strengthened 7.7 percent against the yen in 2013 and is little changed versus the U.S. dollar.
For Alec Letchfield, who helps oversee $416 billion as chief investment officer for the Wealth division at HSBC Global Asset Management in London, the region’s shares are cheap given the steps policy makers are taking to keep the currency union together. The Euro Stoxx 50 trades at 10.9 times estimated earnings, compared with a multiple of 13.7 for the Standard & Poor’s 500 Index and 14.8 for the MSCI Asia Pacific Index, Bloomberg data show.
“You have more chances of upside coming through than in other regions,” Letchfield, whose team holds more European equities than are represented in global benchmarks, said in a phone interview on Feb. 20. Once “people realize that any prospects of euro problems are not there anymore, then they’ll focus on valuations, and they’ll see that actually those valuations are too low,” he said.
Stocks in the euro region will beat U.S. equities in the remaining 10 months of 2013, because American stocks already climbed 6.3 percent as measured by the S&P 500, according to analysts’ predictions. The Euro Stoxx 50 will climb 9.3 percent through the end of the year from the Feb. 22 close, according to a Bloomberg poll of four strategists who track the gauge. That compares with an estimated 1.8 percent gain for the S&P 500 in a separate survey.
The euro-area economy contracted in every quarter of 2012 and will continue to shrink for the first nine months of this year, according to 32 economists’ forecasts compiled by Bloomberg. U.S. gross domestic product will grow 1.8 percent in 2013, Switzerland’s will expand 1.2 percent and Japan’s will increase 0.95 percent, the data show.
The euro region’s risks “far outweigh the potential rewards,” Michael Howell, the founding managing director at CrossBorder Capital in London who correctly forecast that the U.S. housing-market outlook would lead to losses in equities in 2007, said in an interview on Feb. 19.
“Right now, it’s one of the worst times to buy Europe,” said Howell, who studies fund flows and helps oversee $350 million of assets. “The ECB should expand its balance sheet massively. What you’ve got is the euro-zone swimming against the tide.”
Companies from Bilbao-based Iberdrola, Spain’s largest electricity company, to RWE in Essen, Germany’s second-biggest utility, have led losses in the Euro Stoxx 50 this year as euro- area manufacturing contracted for a 19th straight month in February, data compiled by Bloomberg show.
Iberdrola and RWE have each lost 11 percent. Shares of ING Groep NV (INGA) have also slumped 11 percent as the biggest Dutch financial-services company reported fourth-quarter profit that missed analysts’ estimates. France Telecom SA (FTE), the Paris-based former phone monopoly, has dropped 9.8 percent as full-year net income sank 79 percent.
Sales for Euro Stoxx 50 companies will drop 1.6 percent in 2013 from last year while S&P 500 revenue will climb 3 percent, according to more than 10,000 analyst estimates compiled by Bloomberg. Companies in the European gauge will post combined profit that is 30 percent below the 2007 peak, while those in the U.S. will exceed that level by 31 percent, the data show.
In addition to the shrinking economy, any setback to efforts by Italy or Spain to cut budget deficits is likely to hurt European stocks, according to Pictet’s Menon.
Italy’s election, in its second day today, may end Prime Minister Mario Monti’s government, which has overseen a decline in two-year note yields to 1.66 percent from 8.12 percent since succeeding Berlusconi in November 2011.
Italy may be left with a hung parliament as partial results suggested Berlusconi may have built a blocking minority in the Senate to deny outright victory to Pier Luigi Bersani. Prime ministers require control of both houses of parliament.
Spain’s Mariano Rajoy faces corruption allegations that threaten to undermine his austerity drive. The prime minister denied reports in El Pais newspaper that he received more than 250,000 euros in illegal cash payments.
The European Commission cut its forecast for the euro-area economy on Feb. 22. Gross domestic product will decline 0.3 percent this year, compared with a November prediction of 0.1 percent growth, the Brussels-based organization predicted. Unemployment will climb to 12.2 percent, up from the previous estimate of 11.8 percent and 11.4 percent last year, it said.
“We remain very underweight Europe,” Greetham, who recommends buying S&P 500 futures and selling contracts on the Euro Stoxx 50, said at a presentation on Feb. 13. The region will have “sub-par economic growth for years,” he said.
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