Recap 2015-06-12: Europe now vs Japan a decade ago, SPX upside next few weeks


I’ve written in the past that the current EU bond market price action has many similarities to that of the Japanese bond market in the early 2000’s. The chart below shows the German 2s30s curve (blue) vs the Japanese 2s30s curve starting in 2002. (red) I used the 2s30s curve instead of outright yields because we need to adjust for the fact that the ECB has cut rates into negative territory:

I’ve noted in the past that perhaps the comparisons are of limited value because of the differences in the economic back drop. The more I’ve thought about it, however, the more I think that the similarities are bigger than I originally realized. For example, the EU unemployment rate (white) topped out at 12.1%, whereas the Japanese UER (orange) topped out at 5.5%. While the difference looks massive at first glance, I didn’t take into account the difference in the measurement of the data, i.e. who qualifies as unemployed. If we look at the change in the UER instead, the picture looks much more alike. By 2002, Japanese UER rose had risen by 3.5 percentage points from the 1992 lows, where as the EU UER, currently at 11.2%, is up 3.9 percentage points from the 2008 lows:

Of course, no historical analog is exactly alike. In 2002, the global economy was coming out of a recession. But it’s interesting to note that even US interest rates now seem to compare well with then. Here is a chart of the Fed Funds rate now (blue) vs then, (red) with futures-implied levels included:

And here is the overlay of the US 10y yields:

Of course, the axes are different between now and then, reflecting the different levels of growth and inflation, but the resemblances are quite remarkable, at least to me. These resemblances made me dig a bit further.

A simple comparison of the Real Trade Weighted currency levels between Europe now and Japan then initially shows low correlation until recently:

But a look at the longer term picture shows more similarities. The trade weighted EUR peaked in 2008, fell for 4 years, bounced, then resumed falling. The trade weighted Yen peaked in 1995, fell for 3 years, bounced, then resumed falling.

The point is that in the case of the Yen, further depreciation on a trade weighted basis did not occur until 2005, about two years after the BoJ initiated QE and well after the Fed started hiking. Note that this occurred even as the Fed’s hiking path is projected to be roughly comparable to the path then. The take away for the EUR, in other words, is that the further depreciation that is very widely expected may not be coming for several quarters. Specifically, the start of Fed hikes may not cause the EUR to immediately depreciate as is widely assumed.

It’s a bit harder to get a read on how the Eurostoxx will perform using this analog. One reason is that the global economy was in a recession in 2002, which obviously had a large effect on how Japanese equities performed. Japanese equities also started with zero or negative earnings. Differences in the moves in the currency between now and then obviously also has an effect on earnings. There really isn’t a good way to reconcile all these differences, so what I did was rebase the indicies to 12/31/14 and 3/3/03, respectively.

Now, because Japanese equities benefited from a global recovery, one could argue that Japanese corporate earnings benefited more than what could be expected for EU equities this time. EU equities, after all, are already up 65% from the May 2012 closing low. So perhaps the Equities analog is not particularly informative in this case. Readers are welcome to judge for themselves.

Separately, based on sentiment measures, the S&P looks ready to rally. The AAII survey reported that just 20% of respondents were bullish this week, which is very pessimistic reading indeed. In fact, in the past 10 years, the reading has only been lower 4 times. Unsurprisingly, this level of pessimism has historically preceded decent rallies over the subsequent weeks:

This dovetails with my comments earlier this week. Equity market pessimism, a potentially dovish Fed, and economic data that is starting to improve vs expectations. They are all fuel for a risk rally.

Anecdotally, GS notes that calls are quite attractively priced here as well: