European VS. US Equities

Scope ratings HIGH YIELD EQUITies EU VS US
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Guest blog post by Cyril Castelli from our new financial research provider Rcube.

European equities will outperform their US peers in 2016. Several uncorrelated factors are now at work that are clear tailwinds for Eurozone equities on a relative basis.

Lets start with what we believe is the most underestimated catalyst by global investors: The diverging credit channels between the 2 zones.

Over the last 3 years European high yield has significantly outperformed US high yield. We have all the reasons to expect the trend to be sustained in 2016 given that the ECB will now be buying European corporate bonds.

Rcube HIGH YIELD EQUITies EU VS US

This is because over the last 6 years, corporate behaviour  has clearly diverged between the two economic zones. US non financial corporates financing needs have once again reached dangerous levels while in Europe, the non financial private sector has significantly deleveraged.

Rcube chart on financing needs

As a consequence of this, both banks and non banks credit channels are diverging. In Europe, six years of balance sheet deleveraging and now strong ECB support should guarantee that loan officers of European banks should keep easing lending standards to the private sector.

On the chart below we have highlighted our models fair value for both the ECB and the FED credit surveys based on financing gaps and non-financial leverage.  Not only both credit channels are already moving in different direction, but the gap should widen going forward. This is we believe the most unappreciated catalyst for further outperformance of European equities.

Rcube chart Bank Lending Behaviour

Another consequence of the above , is that US investment is likely to remain weak for several reasons.

First with both banks and non banks credit channel being currently tightened, capex financing will be more expensive. As a result the credit channel will be a headwind for the investment cycle, contrary to the last 5 years.

Second, as we have shown several times, the more non financial companies spend on shares buybacks and M&A, the less they are able to invest in the future.

rcube chart

Additional headwinds for US equities are now becoming visible.

The FED is raising  interest rates while forward earnings are negative yoy. This would be the first time since at least the late 80s that a rate hike cycle starts during a profit recession.

rcube graph of FED Funds & Earnings Growth

Furthermore, profit margins are under attack from likely upside wage pressures. Our wage pressure indicator is made of 6 inputs that historically lead wage growth (unemployment gap, small business jobs hard to fill, unemployment duration etc)

rcube wage pressure chart

Diverging currency trends is another factor that should lead to European stocks outperformance.

Relative economic momentum suggest another 7% downside for EURUSD.

rcube chart of EURUSD & Relative Economic Momentum

Dollar liquidity or put it differently, the amount of dollars in circulation is still shrinking. This remains a strong tailwind for the US dollar

rcube chart

Conclusion:

Credit and currency trends are strongly favorable to Europeans equities versus their US peers.

There is significant upside on the SXXP/SPX (Stoxx600 vs. SP500)


 

Click here to read Rcube’s first research report on ResearchPool: Rcube Macro Portfolio 19/02/2016: Rising US Wage Pressures, The Business Cycle And The Dollar

​At the later stage of the economic cycle, wages tend to rise while business optimism has already rolled over. This is, we believe, what is once again happening in the US.

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