Euro Trashed

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 |  Includes: EPP, EWC, EWD, EWG, EWI, EWJ, EWL, EWN, EWP, EWQ, EWU, EZU, FXB, FXE, FXF, GREK, IEV, PGAL, RSX, SPY
by: Eric Parnell, CFA

Summary

European stock markets have been absolutely trashed in recent weeks.

This recent sharp decline has raised concerns among investors about whether such trends may soon spread to other global markets including the U.S.

A closer look at the trading climate around the globe provides clues as to what we might expect in the coming days and weeks.

European stock markets have been absolutely trashed in recent weeks. This recent sharp decline has raised concerns among investors about whether such trends may soon spread to other global markets including the U.S. A closer look at the trading climate around the globe provides clues as to what we might expect in the coming days and weeks.

Isolating The Problem

The decline in European stocks has been notable for its differentiation with the rest of the world. Since the Fourth of July, the iShares Europe ETF (NYSEARCA:IEV) has fallen in price by -7.32%, which is far greater than the -2.22% drop in the S&P 500 Index (NYSEARCA:SPY) over the same time period. This recent performance also compares poorly to other major developed markets over this same time period including Japan (NYSEARCA:EWJ) that is down just -2.71%, Pacific ex Japan (NYSEARCA:EPP) that has been effectively flat at -0.28% and Canada (NYSEARCA:EWC) that is down only -1.94%.

Given the disproportionate decline in European stocks relative to the rest of the world over the past month and in particular since late July, it is worthwhile to take a closer look at the region to assess the exact cause of the decline and to see whether it has the potential to spread.

The first point that immediately becomes apparent from where the source of the pressure is coming. Two countries with measurable market size as a percentage of global stock market capitalization are members of the European Union but have not adopted the euro currency. These are the United Kingdom (NYSEARCA:EWU) and Sweden (NYSEARCA:EWD). Switzerland (NYSEARCA:EWL) is a third that is not a member of the European Union but is closely integrated with the region from an economic perspective. What is notable is that while each of these three non-euro markets have struggled in their own right in recent weeks, each is still measurably outperforming the IEV since early July with the United Kingdom down -5.64%, Switzerland down -5.55% and Sweden lower by -4.60%. Thus, the core of the current stress is emanating from within the Euro Zone.

The second point that becomes even more notable when scanning through the various bourse across the Euro Zone is that the sharp declines are uniform and ubiquitous. Overall, the iShares EMU Index (BATS:EZU) is down -9.46% since early July, which is notably worse than the IEV over this same time period. Digging a bit deeper, the major markets across the EMU are down almost in exact unison since the beginning of July including Germany (NYSEARCA:EWG) down -9.94%, France (NYSEARCA:EWQ) lower by -8.55%, the Netherlands (NYSEARCA:EWN) down by -7.89%, Spain (NYSEARCA:EWP) off by -9.68% and Italy (NYSEARCA:EWI) as the one lone outlier in recent days lower by -13.34%.

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The same has been true to an even greater extent for some of the more notorious smaller markets across the Euro Zone including Greece (NYSEARCA:GREK) that has dropped by -16.38% and Portugal (NYSEARCA:PGAL) that has plunged by -22.51% since early July.

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It is worth noting that currency effects have had little impact in driving these return differentials across Europe since early July, as the euro (NYSEARCA:FXE), British Pound (NYSEARCA:FXB) and Swiss Franc (NYSEARCA:FXF) are all down roughly in tandem with one another relative to the US Dollar during this time period.

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Assessing The Technical Damage

The technical damage that has been inflicted on many of these European stock markets has been significant in many cases. For example, Germany, France and the Netherlands all broke decisively through well-tested support at their respective 200-day moving averages only to find what initially appears to be netting at their respective 400-day moving averages. All are now also solidly lower for the year to date.

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On the smaller market side, Greece has sliced through its 400-day moving average to the downside. And Portugal dropping by -27% over the last two months alone including an -18% drop in recent days essentially speaks for itself.

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Exploring The Cause

So what exactly resides at the core of the problem for stocks in the Euro Zone today? The initial obvious answer would be the fallout effects from the crisis in Ukraine. Russia (NYSEARCA:RSX) currently ranks behind only the United States and China as the third largest trading partner to the European Union. More specifically, Russia is the primary energy provider for many of the Euro Zone member countries. Thus, the fact that Russia faces the prospect of crippling sanctions as a result of their role in the Ukraine crisis has direct spillover effect on European markets. The following chart that shows the high correlation since early July between the RSX and the EZU supports the notion that Russia may be among the primary cause of the recent woes in the Euro Zone.

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But what if something more insidious is going on underneath the surface in Europe beyond the Ukraine crisis? Certainly, the fact that economic growth readings across the Euro Zone have either ground to a halt at best or turned negative in many cases is not supportive of higher equity prices any time soon even in a world still flush with central bank liquidity. Or perhaps it is the dawning realization that this declining growth trend is coinciding with the notable spike in non-performing loans across the region with a concentration in some of the notorious markets from the last go around including Portugal, Italy and Spain. It is upon the foundation of decelerating growth and bad debt that financial crises are spawned. And any such event would almost certainly have a meaningful downside impact on markets around the world.

For these latter reasons, it remains worthwhile to maintain a close eye on market conditions across Europe in general and within selected individual countries in particular to determine whether this is simply a Russian event related pullback or the beginning of something more. After all, these Euro Zone markets combined make up a roughly one-eighth of the entire global stock market universe, so they are meaningful enough in aggregate have an impact on worldwide exchanges. Further technical breaches to the downside would be particularly notable.

Global market conditions are certainly ripe for a more pronounced decline, but such outcomes have continued to prove highly elusive as long as liquidity continues to flow from global central banks. It will be interesting to see if this resilience carries on once Fed asset purchases finally draw to a close in a few months.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long U.S. stocks via the SPLV and XLU as well as via selected individual names. I also hold a meaningful allocation to cash.