We pointed out yesterday the divergence in the performance of the FTSE 100 and the S&P 500, despite there being a great deal of similarity between the performance of the two economies. On this theme, BCA Research, in a report on Thursday, expressed the view that investment allocation process often starts with comparing the economic prospects of one economy with another, and on that basis is flawed when looking what to buy and sell. They argue that it's more relevant to look at a country's exposure to different sectors as this ultimately determines how well the index performs. We pointed out yesterday that the FTSE 100 for example is very exposed to the resource sector. In Germany there is zero exposure to the energy sector. What is common amongst the rest of Europe and the UK, when compared to the US, is the lack of ability to get exposure to the technology sector. Spanish and Italian indices by dint of their lack of manufacturing base are very financially dominated. Italy is also exposed to energy.
The French and German indices are fairly well correlated by sector; the one sector that differs is in materials where Germany has a higher exposure. Hence the performance of the two indices has been fairly similar over the past 2 years. Spain’s dominance in the financial sector partly explains why the index has underperformed the Dax in the past 5 years. It follows if one were to get bullish on European bank stocks one way to do it would be by being overweight Spain’s IBEX index. BCA’s current view is cautious on the energy sector and therefore recommends being underweight countries predominately exposed to that sector for instance Norway and UK.
Merrill Lynch produced a report on Thursday looking at those sectors they regard as cheap and under owned by the investment community. In their view the energy sector valuation is cheap relative to history and under owned, as is the metal and mining sector. In contrast to BCA on that basis, you would own the UK index.
Further on the Merrill Lynch report they study how expensive the S&P 500 is relative to history on a series of traditional matrix. As we know the US leading indices have been the strongest performers by some measure post 2007, and studying the report there is some evidence valuations looked stretched compared to history. The question will now be, if the S&P 500 valuation is stretched will the performance gap be narrowed? Financials make up nearly 25% of the eurozone market capitalization, followed by consumer at 17%; two sectors that are definitely correlated to the strength of the economy.