The contrarian s view on European stock indices

The sell-off in European stock markets has been incessant in recent days, and trying to go long at these levels is starting to feel like catching a falling knife. However, some clever folk over at Bloomberg have developed a tool that lets you track cyclical behaviour in an asset class in an attempt to analyse future price direction.

We decided to test this out with the European stock index, Eurostoxx 50. As you can see, since 1995 this index has been through 5 cycles. The rally from 2003 – 2007 lasted 17 quarters. The sell-off from 2007 – 2011, which saw the index drop sharply during the financial crisis before moving sideways for another few years, also lasted for 17 quarters. This takes us to the present. The current long-term uptrend in the Eurostoxx index started in Q4 2011, if this pattern of cyclical length continues then we may expect the uptrend to also continue for 17 quarters, which would take us to the end of 2015, see figure 1.

We should mention a few massive caveats here. Firstly, Bloomberg did all the hard work for this analysis, we are mere conduits. Secondly, history does not always repeat itself, so just because the couple of cycles prior to this one have lasted 17 quarters does not mean that the current one will. Lastly, we have no idea how the markets would react to an actual Greek default and exit from the Eurozone, which is looking more and more likely. An event of that magnitude may cause a cycle to come to an abrupt halt.

However, if (and that’s a big IF) the cyclical trend continues, then the recent declines in the European bourses could become a good buying opportunity. Something that we brought to your attention a little while ago was the fact that, prior to this sell-off, the Eurostoxx index had been outpacing the S&P 500, see figure 2. However, in recent days the European index has sold off at a faster rate than the US index. If the above cyclical trend is to hold this time around then when the current panic in the market subsides we may expect the Eurostoxx 50 to return to outperforming the S&P 500.

Overall, if European indices can recover from the Greek-inspired sell-off then the boost from the ECB’s QE programme could help to power the long-term uptrend in the Eurostoxx 50 until the end of this year.

Takeaway:

• If the cyclical trend persists then the current uptrend in the Eurostoxx may last until December, suggesting that the current sell-off in European stocks could be temporary.
• If the Eurostoxx index can recover from recent losses then it may return to outperforming the S&P 500.
• Obviously, history does not always repeat itself, especially since a Greek default and European exit could trigger further losses for this index.
• In conclusion, although this analysis is interesting, we recommend using it with caution.