Why does the stock market diverge from the economy?
Last year, while Stoxx Europe 600 earnings dropped c.2%, Euro area GDP grew a decent 1.5% (above trend). We investigate the dichotomy between the European equity market and the economy and find three key areas of substantial divergence: (1) sector and country composition, (2) international exposure, and (3) sector deflationary forces. We believe that a change in the deflationary narrative (a stabilisation in the oil price) and improvement in Financials would narrow the gap between the two spheres.
Heightened dichotomy between equities and the economy
2016 EPS estimates have been revised down 8% year-to-date and marketimplied EPS growth by our DDM is negative. In the meantime, our economists expect 1.4% GDP growth in the Euro area in 2016 – this figure is above trend, and comes after a reasonably good outturn last year too.
1. A different sector and country composition
Should the composition of the equity market be equivalent to that of the economy, SXXP earnings would have grown c.5% in 2015 rather than actually declining 2%. Financials is four times larger in the equity market, Oil & Gas represents 5% of the equity market vs. 1% of the economy, and UK equities are almost twice the size of German equities.
2. A different exposure to the international
While the equity market has 40% international sales exposure (6% to China), the Euro area economy is mainly domestic, with only 1% exposure to China (% of GDP).
3. Different deflationary forces
Our reconstructed price index, reflecting the sector composition of the European equity market, is much more subdued than actual Euro area CPI.