European indices are struggling to make any positive headway. Both the DAX and FTSE 100 are below recent highs and have not made any meaningful progress in more than two months. This is in contrast with a resurgent Wall Street which has been pushing to new all-time highs once more in recent days. There is though one telling difference, the US tech sector has been a crucial driver for Wall Street, something that European markets just cannot match.
- NASDAQ is the dominant force for the S&P 500
- Unless there is a significant improvement in the US “real yield” this outperformance of tech is likely to continue.
- Low tech weighting for FTSE 100 and DAX is the drag
NASDAQ in the driving seat
Below we can see a chart of the two-month relative performance of US markets. The NASDAQ 100 (ie. the top 100 tech stocks by market cap), the S&P 500 and an ETF of the Russel 1000 Value stocks (the top 1000 value stocks in the US). Notice how the NASDAQ (ie. growth stocks) performance ha been huge. The value stocks are barely breaking even on a two-month basis.
The S&P 500 (the middle line) has 40% weighting in tech stocks. It would appear that the vast majority of the S&P 500 gains have been driven by tech.
Falling bond yields are key
Since the “reflation trade” turned sour, the tech stocks in the US have bounced significantly. The move is so significant, that it has resulted in pulling the S&P 500 up by the bootstraps to all-time highs.
Value stocks (companies that are cheaper on valuation, tend to pay a bigger dividend) traditionally perform well when bond yields are rising. When bond yields are falling we tend to see growth stocks (expensive valuation due to future growth potential, but pay little or no dividend, such as the big tech stocks) performing much better. There has been a significant deterioration in bond yields in recent months, allowing tech stocks to outperform.
As we can see in the chart above, the US 10 year Treasury yield has fallen steadily in recent months. With inflation expectations levelling off, this means that “real” US bond yields (the market’s reflection of interest rates minus inflation) have moved even deeper into the negative. This has set up a strong recovery in tech stocks. Unless there is a substantial recovery in US bond yields, we can expect the US growth stocks (ie. tech stocks) to continue to outperform.
DAX and FTSE 100 structurally will continue to struggle
If this trend of falling (or remaining low) bond yields continues, the European indices also seem set up to struggle. Compared to the 40% tech weighting on the S&P 500, the DAX has just 10% and the FTSE 100 a paltry 1%. The FTSE 100 especially is jam-packed with value stocks.
It comes with little surprise therefore that we have seen both struggling for performance in recent months. As the S&P 500 has been pulled to all-time highs by the tech stocks, DAX and especially FTSE 100 are limping sideways.
Note the FTSE 100 is trading marginally lower since late May, whilst the DAX is less than +1% higher. Compare these struggles with the S&P 500 at all-time highs and higher by over +6% driven by a massively outperforming NASDAQ which has added +12%.
European indices technicals set up for ranges
The technical analysis of the European indices reflects these struggles. Both DAX and FTSE 100 appear to be set up for continued trading ranges.
German DAX (MT5 code: GER30) has recently rebounded well from the support band 14,800/15,100 however, this is merely back into a bulk of resistance 15,700/15,800 along with flattening moving averages. A 1000 tick range seems to therefore be forming between 14,800/15,800.
Momentum has also lost its spark, with the Relative Strength Index consistently failing in the mid-50s for the past six weeks. This is settling into a summer of sideways for the DAX.
For FTSE 100 (MT5 code: UK100) the outlook is even less positive than the DAX. The recent rebound from around 6800 (which formed a range low) has failed under what is now a pair of falling 21 and 55 day moving averages. Add in the failing RSI under 50 and the bulls have an incredibly difficult job to find any sustainable traction now.
It seems that the US tech sector performance is the crucial driver behind outperformance on Wall Street. The longer that bond yields struggle, the longer that this will continue. The lack of tech weighting is significantly impacting the performance of European indices.