European equities stick with sweet spot

Multiples

A surge of European stock market volatility abated on Friday, but a downdraft which handed continental indices their worst week since the U.S. election keeps attention focused on Washington. In turn, whilst U.S. equities are extending a bounce that began late in Thursday’s European session, anxieties remain over when or whether the White House's ambitious agenda can begin. With the White House apparently stuck on the back foot until resolution of Russia-related allegations, further unwinding of the so-called reflation trade is foreseeable.

In 10-year Treasury yield terms, the eventual breach of support at 2.179%, at which the rate has reversed three times since mid-November including this week, will be a significant juncture. We can get an idea of how the market prices the call on a fiscal multiplier effect—which looks distant right now—by whether the yield holds above that support. The drift off two-year highs above 2.6% does seem inexorable to us under current circumstances, and the dollar index’s breach this week of a multi-year uptrend at 98.50/98.85 increases the chance that attention will be drawn to the differential if (or more probably when) Washington tensions are heightened again.

Cash flow

In the meantime, for riskier assets, namely shares, the continuing lack of volatility suggests their uptrend can continue for the foreseeable future, on Wall Street and in Europe. In the latter, the additional drivers that appeared most clearly late in 2016 remain in effect. To be sure, the very best yield pick-up from valuation, currency and monetary differentials have probably passed. However, the Trump administration’s apparent weak-dollar bias is creating compelling valuation pockets globally. Such rebalancing trends can be expected to sustain this year’s improvement in European flows, as political risks clear into year end.

In that respect it’s interesting to note that European equity ETFs posted their fifth consecutive month of net inflow outperformance in April, with a rise of €2.3bn followed by bond ETFs which were up €0.7bn, according to Lipper, the fund data provider. The highest assets under management at the end of April were still held by funds classified as Equity US, at €88.3bn, with Equity Eurozone at €49.3bn. But Equity US saw the highest outflows in the month to the end of April. And Lipper said that for a third week to last Wednesday, U.S. investors pulled cash from domestic equity funds and bonds in favour of international markets in both asset classes.

Some of the main cautions for the European stock market right now relate to relative performance and historical valuation. The STOXX Europe 600 has outperformed Wall Street by 4-5 percentage points in the year to date, and posted a 21% price return since the Brexit vote. The S&P 500 has risen 17%. Furthermore the STOXX index was just 5.7% (23.67 points) from its 2015 all-time high by Friday’s close.