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US equities are not as vulnerable as investors believe

RMB’s Roland Rousseau argues that despite expectations of more volatility, equities are not fragile. He does however add that investors should rather consider Europe over the US.

US equities are not as vulnerable as investors believe


By Roland Rousseau


This year the US equity market experienced one of the sharpest sell-offs and recoveries in history. This was compounded by what is referred to as a very narrow market, driven largely by the so-called FAANG stocks.

In the first six days of September, however, these ‘invincible’ technology companies, as measured by the NYSE FANG+ index, collapsed over 12%. Optimists have called this a temporary technical adjustment. Pessimists are saying it is the end of the technology bull run.

Because the market was held up by the very narrow support of a handful of mega-cap US technology stocks, which has now evaporated, some investors are also very concerned that the rest of the market appears to be very vulnerable to further, much broader, and protracted sell-offs.

So, what does our analysis suggest?

How much impact has the September correction really had?

The concerns that the weakness in technology stocks is going to lead to further market weakness and perhaps even a protracted bear market are not supported if we consider the patterns in figure 1.

If we look at the performance of the FANG+ Index relative to the S&P 500 as well as the VIX, which is how options traders price the risk they are willing to take, we observe that implied volatilities immediately normalised to levels we have seen during the last six months.

The market therefore absorbed the September technology ‘crash’ in its stride. We don’t believe the ‘tech risk’ will spread to other parts of the market or that technology stocks will continue to sell off.

Figure 1: NYSE FANG+ vs S&P 500

Source: RMB Global Markets, Bloomberg (click to enlarge)

FANG stocks in 2020 have been more defensive in 2020 than during 2019

In figure 2 we discover something quite counter-intuitive. The NYSE FANG+ Index had a very high beta to the S&P 500 last year in both up and down markets (daily returns for 2019 are the white dots). However, in 2020, the NYSE FANG+ Index has had substantially lower betas to the S&P 500 index despite the Covid crash and the September technology sell-off.

This means that the FANG stocks significantly helped ‘cushion’ the market impact during 2020 on down days. During up days in 2020, the FANG index, on average, lagged the market as represented by the broader S&P 500.

Figure 2: NYSE FANG+ returns vs S&P 500 returns during up and down days in 2019 and 2020

Source: RMB Global Markets, Bloomberg (click to enlarge)

Few would have thought that the large technology stocks would have been ‘defensive’ in 2020, but they clearly have been due to their lower betas. So, to assume, as many market commentators have, that the FANG stocks are very risky to hold, especially given the September sell-off, is very misleading. In fact, by not holding the FANG+ stocks, your average portfolio volatility should have increased in 2020 relative to the other sectors in the US equity market.

We are therefore far less concerned about technology stocks causing market-wide fragility.

Why the EUR/USD is critical for your equity strategy

While everyone is focused on the mega technology stocks, a more important dynamic is playing out for global equity markets. The recent weakness in the US dollar is driving relative equity market performance, and we expect this trend to continue throughout the fourth quarter as we head into US elections and beyond.

A weak US dollar relative to the euro is a good indication of stronger relative performance from European equity markets. This is supported by the fact that Europe is exiting the Covid crisis faster than the US. In addition, strong fiscal stimulus packages are already being implemented in Europe, whereas the US is still arguing about how to deploy their fiscal stimuli.

Figure 3 highlights why we think a weak US dollar is good for overweighting European equity markets versus the US. We show the EUR/USD exchange rate (white) with a simple trend line (green). We then measure the returns of MSCI USA relative to MSCI Europe, whenever the EUR/USD exchange is above/below this trend line.

The graph insert in figure 3 summarises the results. Whenever the US dollar is strong (below trend), US equity markets deliver 32% higher returns per annum than European equity markets. Conversely, when the US dollar is weak (above trend), US equity markets return -10% per annum relative to European equity markets.

This is a substantial difference and indicates how important currency moves can be. If we are entering a sustained weak US dollar environment, which has already been in place for a while now, we believe investors should overweight European equities relative to US markets.

Figure 3: A continued weak US dollar means go overweight European equities

Source: RMB Global Markets, Bloomberg (click to enlarge)

US equity market to remain un-directional

We have argued why US equity markets are not looking fragile and vulnerable to a significant sell-off due to the recent technology correction. However, it is our clear conclusion that the US equity market has run out of steam and that investors should seek better relative returns elsewhere, like in Europe.

We also expect the trade war rhetoric between the US and China to resurface during electioneering, pushing the US dollar onto the back foot, which will make US equity markets more ‘jittery’ than in Europe.


Roland Rousseau is an equity trading strategist at RMB Global Markets.

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