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Playing further outperformance in US markets

Chris Weston
Head of Research
18 may 2023

In the past week, we’ve seen EURUSD finding sellers into 1.0800, and European equities underperforming that of the US. This makes sense given the unfolding economics and flows, and while the NAS100 is clearly loved, I see the probability skewed for further outperformance.

A tactical view on this theme is a Short EUSTX50 / Long NAS100

I like this ratio lower – this means I expect the NAS100 to continue to outperform the EU Stoxx 50. Where if both indices rise, I expect the NAS100 to rise at a faster pace. If they both fall, then the trade works if the NAS100 falls at a slower pace. 

I can currency adjust, so both legs are priced in USD terms – apples and apples. Again the ratio is falling, so it’s not just a EURUSD play. 

The trade case:

  • The trade already has momentum, so I'm not early – a body in motion stays in motion – while it is working, I see the risk skewed for further outperformance from the NAS100.
  • Europe is more reliant on China as a trade partner and Chinese growth is slowing – we’re not seeing a collapse by any means, but the data in China is consistently coming in soft.
  • A weaker CNY (yuan) will incentivise capital to move out of China and would represent a tightening of financial conditions – it will lift imported inflation but promote capital to move offshore.
  • European data is also consistently coming in soft vs expectations and in some cases the data is slowing markedly – German IP and factory orders for example.
  • Everyone is focused on the US falling into recession – I see a greater probability EU falls into recession later this year – the recent Eurozone loan surveys offer insight here and it wasn’t overly pretty.
  • EU inflation is still highly problematic, and the market still sees the ECB hiking another 50bp. Stagflation in any form is not good for asset values.
  • At a simplistic level the Fed are likely to become just that bit more dovish than the ECB – a positive for US assets.
  • EU banks are in relatively better shape than its US peers – however, we could see greater anxiety to hold EU bank equity into 28 June. Here EU banks need to repay E477B in TLTRO loans – about 6% of the ECB’s balance sheet – and represents a massive amount of capital that needs to leave the bank's balance sheets. 
  • This capital drain will almost certainly push up bowing costs for EU banks – a factor I don’t see priced into valuations.
  • Despite some constructive headlines around negotiations there are risks around the US debt ceiling – we all know how the saga ends and ultimately the ceiling will be lifted – however, if we do see increased market stress in early June, then it will impact EU equity too. 

As with any trade a stop loss represents how much risk I can take on – here, I would look to close when the ratio pushed above 0.34. Long/short strategies tend to have longer hold times.

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