MONEY IS ROTATING INTO THE EUROZONE WHICH IS OUTPERFORMING THE U.S. -- BRITISH STOCKS ARE LAGGING BEHIND -- BRITISH ISHARES HAVE BEEN HURT BY A WEAK POUND -- ROTATION INTO EUROPE MAY SLOW U.S. RALLY, BUT SUGGESTS GLOBAL BULL MARKET IS STILL INTACT
EUROZONE STOCKS ARE ATTRACTING GLOBAL FUNDS ... Part of the reason that U.S. stocks haven't been doing so well during 2017 is that global funds are moving into other parts of the world. Especially to Europe. More specifically, the eurozone. The reason is simple. U.S. stocks are considered to be more expensive, while eurozone stocks are viewed as a better bargain. The following charts support that view. The gray area in Chart 1 shows the strong rise in the S&P 500 over the last three years. The blue line shows the MSCI Eurozone iShares (EZU). There are two reasons why I'm using the EZU. First, it excludes the UK (more on that later). The second is that the EZU is quoted in U.S. dollars (as are all foreign ETFs). As a result, it more truly reflects the impact on American investors whose profits and losses are measured in dollars. Chart 1 makes clear that the S&P 500 did much better than Europe over those four years. The SPX gained 26% versus a -2% loss for the EZU. Since last July, however, the EZU has outgained the SPX by a 17% to 11% margin. Since the start of 2017, the EZU has gained twice as much as the SPX (8% versus 4%). And that's why money is now rotating out of the U.S. into the eurozone. Money tends to go where it's treated better.
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Chart 1
EUROPE SHOWS BETTER RELATIVE STRENGTH ... It's not enough to say that Europe is cheaper than the U.S. European stocks have lagged behind the U.S. for the last eight years. There has to be some evidence that the tide is turning in favor of Europe. And there is. As usual, ratio analysis is the best way to view that. The blue line in Chart 2 is a relative strength ratio of the Eurozone ETF (EZU) divided by the S&P 500. To the bottom right, the chart shows the eurozone/U.S. ratio turning up in March, which formed a pattern of "rising peaks and troughs" that started last November. The ratio also broke a falling trendline extending back to 2015. And it clearly shows that the tide has turned in favor of the eurozone. There are a couple of important messages there. First, it suggests that global leadership may be shifting from the states to Europe. It also suggests, however, that the global bull market is continuing, just with new leadership. That should be good for the U.S.
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Chart 2
EUROZONE WITHOUT THE UK... Chart 3 is designed to show that the eurozone is a stronger bet than Europe as a whole. The blue line is the Eurozone ETF (EZU), while the red line plots the Europe iShares (IEV). Both are rising. But the blue line is rising faster. Since the end of November, the EZU has outpaced the IEV by a 15% to 13% margin. Both, however, did better than the S&P 500 gain of 6%. The stronger performance by the eurozone is also shown by the rising EZU/IEV ratio on top of Chart 3. That outperformance is most notable since last July right after the Brexit vote. Which brings us to the main reason why the eurozone ETF is leading. It doesn't include the UK.
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Chart 3
UK LAGS BEHIND THE EUROZONE... The biggest reason the eurozone is doing better than the rest of Europe is because of weaker performance by British stocks. Three of the biggest holdings in the EZU are France, Germany, and Spain. Chart 4 shows strong performances by their respective ETFs since last July. Spain (EWP) led with a 25% gain. Germany (EWG) and France (EWQ) rose 18% and 16% respectively. [The Netherlands (EWN) and Italy (EWI) rose 18% and 17%]. By contrast, United Kingdom iShares (EWU) rose only 7%. That's the bottom line. And the UK is the biggest holding in the IEV (28%). That alone explains why the eurozone ETF (EZU) is stronger than the Europe ETF (IEV).
Chart 4
THE FALLING POUND MADE A BIG DIFFERENCE... Chart 5 demonstrates how important a currency is when investing in foreign markets. The black bars show the London FTSE Index climbing 9% to a record high since the Brexit vote last June. That may look good to an American investor. The British Pound, however, plunged nearly 20% after the Brexit vote (see green line). And is still 14% lower than last June. As a result, British iShares (EWU) tumbled relative to the FTSE (see red line). The red line plots a ratio of the EZU divided by FTSE, and shows how much the EZU has underperformed the FTSE. Since the Brexit vote, the EWU has gained only 2% (versus 9% for the FTSE which is quoted in sterling). The tumble in the pound gave a big boost to FTSE exporters which pushed the FTSE to a new record. That did little for American investors who lost money on the falling British currency. Their performance is reflected in the red line, not the black bars. The recent upturn in the pound carries good and bad news. It's pushed the FTSE lower. However, it's boosting British iShares which are rising with the currency. That shows why American investors are better off tracking foreign stock ETFs when looking abroad. That's what their returns will look like.
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Chart 5
CYCLICALS AND SMALL CAPS LEAD STOCKS HIGHER... The fact that foreign developed and emerging markets are rising faster isn't necessarily bad for U.S. stocks. That's because global stocks usually trend in the same direction. And that direction is still up. U.S. stocks appear to be following foreign stocks higher today. Chart 6 shows the S&P 500 SPDR (SPY) trying to regain its 50-day average. Small caps are doing even better. Chart 7 shows the Russell 2000 iShares (IWM) trading above its 50-day line and reaching a two-week high. Economically-sensitive stock groups like financials, industrials, and materials (steel stocks) are leading the rally. So are the transports, led by rail stocks. That list includes cyclicals. Chart 8 shows the Consumer Discretionary SPDR (XLY) reaching a new high. It's being led higher by apparel retailers and auto parts. Today's stock action is encouraging. But it will be a lot more encouraging when some upside breakouts are achieved.
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Chart 6
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Chart 7
