U.S. Equities Ignore Economic Weakness as Capital Flows From Eurozone

Includes: EZU, SPY, VT, VTI
by: John Furlan

Capital continues to move from euro assets to dollar assets. This is the very simple explanation for why U.S. equity markets are not falling in the face of poor news, e.g. on Greece, U.S. unemployment claims, durable goods orders, existing and new home sales, consumer confidence, etc.

The huge issue for investors is whether the U.S. will lift global equities up or global equities will drag U.S. equities down.

Most mainstream market commentators that I see and read don't emphasize this rather obvious explanation of why U.S. equities continue to shrug off poor news, which I've written about on Feb. 18 and Feb. 24. (See my Feb. 22 Instablog for the recent views of Lowry and others.) In my Feb 24 article, I showed how I disaggregate global relative strength into its components, using the case of U.S. small cap stocks.

Here's another useful way of using the same technique, in this case to look at the absolute performance of the overall U.S. market, rather than its global relative strength, to show why even though the U.S. is greatly outperforming euro assets, its absolute performance has recently flattened out, centered around SPX 1100, within a range of the Jan. 19 high of 1150 and Feb. 5 low of 1044.

I will use the Vanguard Total Stock Market ETF (NYSEARCA:VTI) as a proxy for U.S. equities, Vanguard Total World Stock Index ETF (NYSEARCA:VT) as a proxy for global equities and iShares MSCI EMU Index (BATS:EZU) as a proxy for European equities. (I usually use iShares MSCI All Country World Index - ACWI - as my global proxy; I'm using VT here simply to go along with VTI.)

To disaggregrate the performance of VTI, my formula is: VTI/EZU x EZU/VT x VT = VTI. The numerators and denominators cancel out. (More than 20 years ago, I took that idea from the old duPont formula for ROE analysis and applied it to relative strength analysis.)

I'll "multiply" out visually the charts below, so you can get a sense of how this formula works.

These four charts show that U.S. equities are greatly outperforming European equities, but the latter are greatly underperforming global equities, the two multiplied together offset each other, so U.S. equities are moving sideways along with global equities with an upward bias favoring the U.S., i.e. gaining global relative strength.

Before going through the charts, a quick update on ECRI's Weekly Leading Index [WLI] which I noted in an article published on Feb. 7 was starting to show a slowdown in U.S. growth around mid-year. That continues to be the case, with ECRI saying today: "The decline in WLI growth to a 28-week low reinforces our earlier expectation that economic growth would begin to ease by mid-year."

A slowdown in growth is not a recession, and the market consensus is already for a sharp slowdown from the fourth quarter's unsustainably high 5.9% GDP growth. So the issue is to what extent this GDP growth slowdown is being reflected in 2H SPX EPS estimates. For a fuller discussion on the process of forming extended market tops, see my two long Instablogs from Feb. 6 and Feb. 5.

(Click charts to enlarge.)

First, VTI/EZU chart shows U.S. equities greatly outperforming euro equities.

Next, EZU/VZ shows European equities greatly underperforming global equities, essentially offsetting the outperformance of U.S. equities over Euro equities shown in the first chart.

Next, a simple chart of VT, showing that global equities are moving sideways. I want to strongly emphasize that this chart of global equities is at a very critical point right now, with its 100-day EMA flat after slightly declining for the first time since last February. There is already a lower low in this chart, a failure to rally will put in a lower high, and the 50-day EMA would cross below the 100-day EMA.

Finally, a simple chart of VTI, showing it still moving slightly upwards, while essentially the first two ratios (VTI/EZU and EZU/VTl) don't completely offset each other, so that VTI is currently modestly outperforming VT, as shown by its still-rising 100-day EMA, as opposed to declining for VT; and unlike VT, VTI does not have a lower low.

Disclosure: No positions in stocks, ETFs mentioned.