According to analysts at the German bank, European stocks are at the mercy of a slowdown in positive macro surprises.

Citing the close relationship between global stock-market performance and better-than-expected data across major economies since November 2016, analysts at Deutsche Bank AG warns that a slowdown in positive economic surprises may set the stage for a pullback in European equities in the coming months.

According to an analysis by the German bank, about 71 percent of the worldwide rally in equities is explained by the firming of economic data around the globe.

That means that the way for a correction may be being paved by the unexpectedly strong economic indicators over the past six months. These indicators have helped European cyclical stocks stage their sharpest rally since 2009.

“Global macro surprises have only been higher 5 percent of the time since 2003 (when the data series starts),” European equity analysts, led by Sebastian Raedler, wrote in a note on Thursday. They typically falter at these elevated levels, he said, “and have shown first signs of softening over the past week.”

Raedler and co. reckon investors can snap up European stocks at more attractive levels as the boost from macro surprises diminishes mid-year but forecast the Euro Stoxx 600 will close 2017 at 375, implying a 2.2 percent upside from current levels.

According to a Deutsche Bank index, macroeconomic surprises are now at their highest level since May 2010. With all four of the world’s biggest economies in positive territory, the surge in better-than-expected data posted over the past year was highlighted by the more-widely used Citigroup Surprise Indexes. Only Japan has dipped below the line, since November.

Combined with expectations for higher growth in the U.S. since the election and as easier financial conditions have helped to power a surge in manufacturing output, global stocks have been on a tear over the past six months. While the S&P 500 Index surged to a record on Wednesday and the Dow Jones Industrial Average jumped past the 20,000 threshold, the Euro Stoxx 600 has notched a 9 percent gain since the November poll.

Economic surprise indexes, which tend to be mean-reverting in nature given the propensity of economists to price-in conditions once they transpire and which measure the results of economic releases relative to analysts’ expectations of them, have caught the attention of investors.

For their correlation with company earnings, the indexes have also garnered market attention. As fourth-quarter earnings season kicks off, better-than-expected economic data in recent months should be a boon for European stocks this month, analysts at Morgan Stanley wrote in a report last week.

Citing the lagging nature of economic data and the disproportionate weight attached to initial releases relative to revisions, Mark Tinker, head of AXA Framlington Asia, who is skeptical of the attention lavished on surprise indexes by investors, provides the counterpoint.

“The market will herd in one direction on the back of data surprises, offering an opportunity to trade in the other direction,” he wrote in a client note last week. “We don’t need to predict the move, just wait for the ‘new data’ to be priced in, then move the other way.”

(Adapted from Bloomberg)

Categories: Economy & Finance