Last week was marked by an improved sentiment in the US, but not so much in Europe. The US equities had a strong week: the S&P 500 rallied 1.68% over the week, Nasdaq 100 gained 1.87% - and that despite Nvidia (NASDAQ:NVDA) that finally closed the week flat as the earnings disappointment kicked in with a small delay and costed the company a more than 3% retreat on Friday. The Dow Jones rallied nearly 2%, while the small caps rallied jumped nearly 4.5% on further rush to Trump trades. SPDR’s energy and financial ETFs hit a record high, the US Dollar Index rallied to the highest levels in two years and of course, Bitcoin – the ultimate Trump trade - flirted with the $100’000 psychological mark and consolidated gains slightly below that level during the weekend.
In Europe, things looked much less encouraging. First of all, the Stoxx 600 index tipped a toe below the 500 mark at the start of the week, and even though Friday ended on a positive note, the move was driven by a ‘bad news is good news’ type of motivation.
European Equities Are Cheap, but...
The data released Friday looked all but encouraging. Growth in Germany slowed in the Q3 and the yearly figure printed a faster contraction of 0.3%, versus the expectation of a stable contraction near -0.2%. The PMI figures came in lower than expected: the flashing red French numbers – especially the unexpectedly fast deterioration in the French services sector - pushed the Eurozone services, and composite PMI into the contraction zone.
Obviously, the bad set of data boosted the expectation that the European Central Bank (ECB) could opt for a 50bp rate cut in December rather than a moderate 25bp cut in an attempt to catch a falling knife. On Monday, the European companies trade with a 40% discount on their S&P500 peers in terms of PE valuations. But the ECB alone could hardly give the European businesses a strong basis to thrive in the long term. Europe needs much more than monetary support to get back on its feet.
First, the strict regulatory environment in Europe makes it extremely difficult for European companies to innovate, and that’s something that the ECB can not solve with lower rates.
Second, the luxury goods companies contribute to around 8-10% of the European market capitalization during strong market periods. In France, the luxury stuff makers stand for more than 25% of the CAC 40's market cap, making it one of the most heavily weighted sectors in this index – and this percentage is around 10-12% for MSCI Europe. These companies need a strong demand from EM markets, especially from China. The fact that the Chinese economy is not doing great and the fact that the European policymakers are doing everything in their power to escalate trade tensions with China – by imposing their companies big tariffs – are not encouraging.
The same is true for the zone’s carmakers. Having missed the EV turn, and the escalating tensions with China are not having a good impact on the German carmakers, the industry is facing a massive crisis – the biggest since WW2.
ECB Chief Christine Lagarde said at last Friday’s European Banking Congress that ‘since last year, Europe’s declining innovation position has come more clearly to light,’ and that ‘technology gap between the US and Europe is now unmistakable.’ Her comments echoed Mario Draghi’s call for an 800bn euro innovation fund that the European companies should finance together with supra-sovereign bonds to compete better with the US peers.
So yes, the lower company valuations in Europe and the growing valuation gap with the US companies attract some investors with the prospects of lower ECB rates. Yet, the European economic tissue needs more than just the ECB cuts to get back on its feet. It needs deregulation and international cooperation. And it’s not on the menu du jour.
In Europe, Swiss and UK names are expected to perform better. Swiss, because of the country’s neutral and defensive nature, and stable economic and political environment. And FTSE 100 because its financial, energy and commodity focus is interesting in a period of easing monetary policies, and the big dividends that its big companies pay out are interesting for hedging against a potential uptick in global inflation that could jeopardize the easing monetary policy plans to some extent.
In the FX
The US dollar’s surge last week, combined to the weakness of the European data, sent the EUR/USD to a dark hole. The pair tanked to 1.0330 and rebounded strongly after hitting that dip, and consolidating near the 1.0480 level at the time of writing. I expect some consolidation and dip buying near the current levels for tactical longs.
Week Ahead
This week will be a holiday-shortened one in the US due to Thanksgiving, with most news and data packed into the first three days. Highlights include the FOMC minutes on Tuesday, followed by growth, PCE, and jobs data on Wednesday. Meanwhile, European countries will begin releasing their preliminary November inflation figures from Thursday. The fresh CPI figures will either solidify expectations of a 50bp ECB rate cut in December or challenge them, potentially giving the euro a boost. But as mentioned last week, further EUR/USD selloffs may present good buying opportunities below the 1.05 level.