European catch-up has just begun

Published On: April 21st, 2021|By |Categories: Market Updates|2.8 min read|

Last week saw the continued retreat in U.S. bond yields despite continued signs of economic strength and rising inflation. This is not unusual given the extreme sell-off in government bonds in the first quarter and substantial investor pessimism towards the asset class as the second quarter commenced. We do expect the climb in yields to continue once oversold conditions are worked through and the persistent strength in economic data confirms that the current global recovery is not just a transitory phenomenon.

US Treasury Bond Yield (%) | US Treasury 2Y/10Y Spread (bps)

It is noteworthy that the pause in the rise in U.S. yields and the accompanying recent underperformance of cyclical stocks has mostly been confined to the U.S. In Europe, the recent consolidation in yields and relative cyclical stock performance has been less pronounced and maybe signaling a shift in the trend of U.S. outperformance versus the rest of the world. German yields continue to hover close to recent highs and the performance of European cyclical stocks relative to more defensive stocks remains firmly intact (chart below).

Germany 10-year yield vs Europe Cyclicals Relative Defensives

Despite the well-known setbacks in Europe in its vaccine rollout and economic reopening, indicators of economic expectations continue to trend higher in anticipation of the inevitable European recovery.

Germany: ZEW Profit Expectations for Autos (NSA, % Bal) |Germany: ZEW Inflation Expectations (NSA, % Bal)
Rising confidence in European corporate prospects

Rising confidence in European corporate prospects is starting to be reflected in analysts’ estimates of future earnings. The pro-cyclical bias of European company earnings meant they declined more than U.S. earnings following the outbreak of the pandemic and have been slower to recover due to the heavier weight of government restrictions (graph below). However, over the last few weeks European earnings revisions have been rising at a faster pace than that of their U.S counterparts. Investors are starting to recognise that the game of catch-up has just begun.

Daily NTM EPS Progression

The strong outperformance of U.S. equities relative to the rest of the world over the past 10+ years has naturally led to an entrenched U.S. overweight position. The conviction of that position will be tested as Europe reopens and the positive momentum in relative earnings upgrades continues. As the chart below shows, this extended period of extreme outperformance has led to an unprecedented valuation gap. Indeed, if the regional investing game is changing, it certainly has a long way to go before it becomes exhausted on its fundamentals.

Shiller Cyclically Adjusted P/E: MSCI USA & MSCI EAFE
Investors embrace risk

We have recently highlighted some of the indicators that are starting to reach levels consistent with an increased risk of a market correction. Investors are certainly embracing risk to a much greater degree than was the case just six months ago. The chart below measures seven sentiment indicators as to their current level versus their historic extremes. Four of the seven indicators are in the 95th percentile of their historic optimistic readings. This is not fatal to the continuation of the market advance. It just highlights the risk as extreme investor optimism combined with stretched valuations leaves the market vulnerable to any unexpected negative developments.

Sentiment Dashboard


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David Williams (1970) is verantwoordelijk voor het beleggingsbeleid van Mpartners. Na een korte carrière bij het Ministerie van Buitenlandse zaken van Barbados begon David in 1997 bij Insinger de Beaufort Asset Management en in 2002 werd hij director. Hier droeg hij verantwoordelijkheid voor het investment team en de beleggingsfondsen (zowel long-only als gehedgde portefeuilles). Zijn specialisatie is Europese aandelen. In 2010 heeft hij samen met de andere partners Mpartners opgericht. David Williams heeft een B.A (Honors) van de University of Kent, een M.Sc. in Internationale Politieke Economie van de London School of Economics en een MBA van Nijenrode.