One persistent theme of the past decade has been underperformance in European stocks compared to U.S. stocks. This is reflected in differences between the two economies. The European Union (E.U.) has grappled with deflation and barely positive growth for a number of years with brief periods of anemic growth. While US growth and inflation rates are far from dynamic, deflation nor negative growth has ever really been an imminent threat.
One contributing factor to this difference are fiscal deficits which have been anywhere between $500 billion and a $1 trillion in the U.S. In the E.U., there is no mechanism for fiscal deficits and the only tool is monetary policy. The European Central Bank (ECB) has been aggressive in lowering rates and using its tool to suppress bond yields even for countries with shaky finances and growth rates. It's been so successful that there are head-scratching examples like Spain's 10Y note yielding 0.27%, and Greece's 10Y debt yielding 1.72%. Both yields are lower than the US 10Y note at 1.8%.
Stock Market Performance
It seems that this aggressive monetary efforts are beginning to yield fruit as European stocks have begun to outperform against U.S. stocks. While the S&P 500 sits 5 points below its July high of 3,029, the DAX, the German stock market, exceeded its July high two weeks ago and is almost 3% higher from those levels.
Since 2011, the S&P 500 (SPY) has outperformed the German stock market almost 80% of the time. However, there have been brief periods, where the DAX outperformed for months. These are late-2011 to early 2014, late-2014 to mid-2015, and mid-2016 to mid-2017. All of these time periods have notable similarities to the current market.
All of these represented time periods, where the broader market was strong from a price perspective but plagued by geopolitical worries dampening investor enthusiasm. The excess bearish sentiment prevented stocks from falling too far and created ripe conditions for future gains, when a bullish catalyst presented itself.
Looking Forward
Although it's counterintuitive, outperformance in European stocks is a bullish omen for stocks. It indicates that liquidity is plentiful and risk appetites are healthy. As long as this outperformance continues, bulls should feel emboldened to buy breakouts and pursue bullish strategies, while bears should be selective and manage risk aggressively.
What's interesting is that stocks are anticipating some sort of positive economic developments in Europe whether that's due to more aggressive monetary policy, fiscal initiatives, or the business cycle turning. Currently, the economic data has been lousy, as exporters in the country have been a victim of the trade war slowing international trade. Over the longer-term, this trend and divergence deserve continued attention.
