Safe European shares in demand

European shares at lowest in two years

The way this has played out in European stock markets, is that investors are now positioned in a direction that anticipates further geopolitical uncertainty. Everything from Washington’s stance on trade through to White House turmoil, and then more specific to the region, months of trepidation over Italy and of course Brexit, have handed the STOXX index its worst performance in two years. One way of illustrating the impact on Europe’s stock market sectors in more detail and of illuminating which sectors could be favoured in the near term is to use a charting system called Relative Rotation Graph (RRG). The system uses proprietary calculations, but its aim and internal validity are easy to recognise and understand. Asset values are first normalised, as in the re-based chart above. Secondly though, they are plotted over four quadrants as shown in the RRG below. It contains all twenty industrial sub-indices compiled by STOXX. By utilising labels ‘Improving’ ‘Leading’, ‘Weakening’ and ‘Lagging’, RRG portrays the performance of assets relative to a benchmark. In this case the benchmark is the broad STOXX Europe 600 gauge. Note that each triangular point on the chart represents a one-week interval and 12 were charted in total. More background on the technique can be found here.

Tell-tale demand for utilities and telecoms

It is immediately apparent that the sectors in the ‘leading’ quadrant –Telecoms and Utilities – are the stock market’s traditional ‘value’ or bond-like proxies. They are typically unloved under normal circumstances. Their position at the front of investors’ preferences right now suggests a powerful impulse for safe-havens is well established and should colour the next few months at least. It should also be little surprise that Energy (including crude oil shares) crossed from the ‘Weakening’ segment into ‘Lagging’ last week, confirming that investors are fleeing such industries but also implying that it they are just at the beginning of declines. If the graphic is any indication of what happens next, it’s unlikely to be pointing to a quick rebound for oil shares.

Tech troubles just beginning

Moving deeper into laggard territory, to the right, another standout is the technology sector. Europe’s version of such industries is more heavily weighted towards hardware than software, particularly semiconductors. The main semiconductor stock index, was, like many market indices, hitting new multi-month lows on Monday, as broader pressures damped hopes that one of the sector’s frequent cyclical downturns that began earlier this year could lift soon. Two surprises at first look are the appearance of STOXX’s Banks and Autos & Parts indices in the ‘Improving’ quadrant. Whilst this gels with their relatively protracted time among underperforming segments that may now be attracting interest from investors using rotation strategies, guidance about RRG interpretations is cautionary. The spatial position of assets in the chart is important. Typically, the clearest indications are meant to be provided when prices are as far away from the intersection of the X and Y axis as possible. Since the central area represents performance in line with the benchmark, prices that have not unequivocally pulled away from the centre of the axis portray a more ambiguous picture of investors’ preferences. Hence it may be too early to say whether Europe’s car sector, close to the epicentre of the trade dispute is set for unmistakeable outperformance any time soon. Similar can be said about the banks.