EUR strength is the primary reason for European equity weakness. Lacklustre is perhaps the best way to characterise the current performance of European equities. While weak earnings trends and heightened geopolitical risk (e.g. Brexit) may be partly responsible, FX markets are arguably the greatest influence on tactical performance with EUR strength corresponding with falling equity prices and vice versa. Despite the last 12m of ECB QE initiatives the EUR trade weighted index is now at its highest level since Jan-15.
FX has never had such a strong influence on equity markets. The last month has seen a very significant divergence in regional equity performance with US and EM stocks rising and European and Japanese equities falling. Expectations of a more dovish Fed and a commensurate move lower in USD have been the key drivers of this divergence. We struggle to remember a time when FX had such a dominant influence on equity markets, an assertion supported by the below chart that shows an extreme negative correlation between the EUR trade weighted index and the performance of MSCI EMU.
European equities at all-time low relative to US stocks. Over the last month MSCI Europe has underperformed MSCI USA by 5.6% in local currency terms, a level of underperformance that has only been exceeded in four months over the last decade. Post this move MSCI Europe trades at a record relative price low to MSCI USA whether measured in USD or local currency.
If you think European equities are bad, spare a thought for Japan. As poor as European equity performance has been in recent months, it has been materially worse in Japan. Over the last 3M MSCI Japan has underperformed MSCI Europe by 11.7%, a degree of underperformance that has rarely been exceeded over the last ten years. Japan’s underperformance to global equities has been even greater (-15% over the L3M). With expectations now growing that the Japanese authorities will have to take further (potentially large) action in the face of ongoing Yen strength the stage may be set for a rally in Japanese stocks.