A story of opposites is a fitting description between European
and U.S. markets.
Sitting on one side of the Atlantic is the S&P 500 Index (SNP:
^ GSPC), which traded only 10% below its 2007 all-time high just a
few months ago. U.S. companies also reported record earnings.
On the other side of the pond is Spain's stock market (NYSEArca:
EWP) which now trades more than 50% below its 2007 high. But Spain
is not the only weak link in the chain. France's CAC 40 also trades
50% below its all-time high and even Germany's DAX is off by more
than 20%.
Even the broader MSCI EAFE Index (NYSEArca: EFA) is down some 40%
since its 2007 high.
Market dislocations this large are unusual, so the key question
is this: Will the U.S. market lift Europe or will Europe (NYSEArca:
FXE) drag it down?
Monkey See, Monkey Do
This week the European Central Bank (ECB) took a page from the
playbook of the U.S. Federal Reserve. The ECB lowered the deposit
and main refinancing interest rate between 0.75% and zero percent.
"Downside risks to the euro-area economic outlook have
materialized," said Mario Draghi, ECB President. Draghi's statement
can easily be categorized as understatement of the week and
possibly of the year.
The ECB follows the same path as Australia, China, Japan, U.K.
and U.S. Here's what's occurring: Financial maneuvering by global
governments, from asset purchases to near zero percent interest
rates, are being tried. And yet other tactics will be tried.
Thus far, the ECB's tactics haven't worked. Unemployment in the
region reached a record of 11.1% in May and confidence has fallen
to its lowest point over the past two years. The European
Commission expects 0.3% shrinkage in economic activity and more
downward revisions are ahead.
Reversion to the Mean
International and emerging market stocks (NYSEArca: EEM) easily
outperformed U.S. stocks from 2009-10. When U.S. stocks were
lagging, the rest of the world was rising. The short-lived
blistering outperformance of Spanish stocks (NYSEArca: EWP) versus
the S&P 500 (NYSEArca: SPY) circa 2009-10 is seen on the chart
below.
Like many markets throughout the history of time, the
performance discrepancies between international and U.S. stocks
grew in early 2010. That was roughly around the same time Wall
Street's strategists were telling their clients to load up on
foreign stocks. But these distortions of international
outperformance versus the U.S. were only temporary.
The February 2010 ETF Profit Strategy Newsletter (published in
mid-January 2010) observed this and alerted: "Current prices
provide an excellent opportunity to take, maintain or add to
bearish positions." Shortly thereafter, Spanish stocks, along with
the rest of the market, reverted and a severe correction
occurred.
Don't Miss the Next Reversion...
European indexes have already succumbed to their reversion, while
U.S. stocks are still plugging along. And while history shows these
discrepancies can occur over unusually long periods, they are never
indefinite.
Spain and Italy (NYSEArca: EWI) together have an economy that's
11x larger than Greece. You don't want to be fully invested when
that bomb goes off. A reversion to the mean, like gravity, is not a
force you want toargue with.
The
ETF
Profit Strategy Newsletter's
goal today - as in 2010 and 2011 - is to issue the kind of warning
that gets investors out of stocks before the next leg down. When
stocks fall, they tend to fall hard, and an ounce of prevention is
worth more than a pound of cure (the Newsletter issued a sell
signal at S&P 1,386).
Follow us on Twitter @ETFguide