U.S. Market at Record Highs But Trouble is Brewing in Europe

By David Nelson, CFA

Right out of the gate stocks marched higher this month picking up where January left off. The broadcast and print media both point to the animal spirits unleashed following the election and to be fair some of the rhetoric is true. However, when you dig deep that’s not the entire story.

To the extent that the prospects for tax reform, repatriation and regulatory overhaul are priced into the market investors have to reconcile the timeline to something more realistic. Speed is not a word often associated with Washington and like most things in life the devil is in the details.

Sector vs Market Performance

As for U.S. markets, strength could be seen in all sectors with the lone exception being Energy (XLE). Post the OPEC announcement last year that they would make a modest cut to production, energy bulls have been looking for a cyclical upturn to the energy complex.

In a world where OPEC no longer commands the cartel like influence of previous decades the driving force behind energy prices will be economic output. To the extent that the world economy improves oil can push higher. It’s important to remember that each dollar higher in crude brings more wells back online here in the states. The wild card is of course supply disruption from a geo-political conflict.

Growth vs. Value

After being taken to the woodshed last year Growth (IVW) has retaken the lead outperforming its Value (IVE) counterpart year to date. Of course the leading driver behind the comeback for (IVW) is Apple (AAPL) the largest component in the index.

S&P Earnings Estimates

While current multiples are a bit stretched, earnings estimates for the S&P 500 (SPY) on a blended 12 month forward basis continue to move higher. As long as that picture holds true I suspect any pull back in the market will be bought.

Something to worry about

If you’re looking for something to worry about turn your attention across the pond to Europe. Despite improving data, trouble is brewing in Euroland. This can be seen in widening debt spreads between France and Germany. The chart goes back to the currency crisis of 2012 and charts the spread between the 10 year yields of France over Germany. The downward trend ended in 2016 and is clearly widening further as we approach the French Elections. Regardless of the outcome those who want to leave the EU and even the Euro itself have a voice that seems to be getting louder.

I’ve long believed it’s difficult if not impossible to sustain a common currency without a common government. If in fact one or more countries pull out of the currency the Euro denominated debt will revert to the local currency creating essentially the biggest default in history. None of this is on our door step just yet but is food for thought.