Extreme Moves: European & US Tech Stocks (Transcript)

By datatrekresearch in Blog

The Nasdaq 100 and S&P 500 Tech sector recently had 3 standard deviation moves to the downside over the prior 50 trading days, while MSCI Europe just outperformed the S&P 500 by 3 sigmas over the last 100 trading days. Both moves are extremely unusual, so in our latest video we discuss whether they can continue or are due to mean revert in the coming months.

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Transcript

Hi, I’m Jessica Rabe, co-founder of DataTrek Research. In today’s video I am going to discuss 2 of the most extreme moves in global equity markets to come out of all the recent volatility. The first is the dramatic downside move in US Tech stocks, and the second is the equally remarkable outperformance of European equities versus the S&P 500.   

In both cases, the history I will show you strongly suggests that Tech is due for a bounce and US large caps are set to outperform Europe over the coming months. Even still, the current investment environment is highly uncertain, so I will also discuss why recent trends may persist even though the data says we’re due for some powerful mean reversion.

Let’s first look at US large cap Tech since both the Nasdaq 100 – ETF symbol QQQ – and S&P 500 Tech sector – ETF symbol XLK – just had 3 standard deviation moves to the downside over the last 50 trading days, which is roughly 2 ½ months.

First, here’s a chart of the Nasdaq 100’s 50-day trailing price returns back to 2015. The solid line marks the average return, and the dotted red line reflects the 3 standard deviation downside level.

And here’s a chart of the S&P 500 Tech sector’s 50-day trailing returns over the last decade. Again, the solid and dotted red lines mark the average return and 3 standard deviation downside levels.

I have 4 quick points on these charts.

The first is that the Nasdaq 100 and US large cap Tech sector have, on average, gained 3.4 and 3.6 percent over any given 50 day holding period back to 2015. Their standard deviations are roughly 8 points, so 50-day downside moves of over 20 percent are 3 standard deviations below their long run means.

Second, both QQQ and XLK’s 50-day returns have been positive three-quarters of the time over the last decade, so their recent underperformance is very rare.

Third, QQQ and XLK both fell by over 20 pct over the prior 50 trading days early this month, again both 3 sigma moves. For both QQQ and XLK, that’s only happened on 13 trading days over the last decade, or just 0.5 percent of the time. Before this year, they only hit 3 sigma downside moves during the Pandemic Crisis in March and April 2020, and the Fed rate shock in 2022.

Fourth and lastly, when the Nasdaq 100 and Tech sector’s 50-day returns have fallen by over 20 percent in the past, they’ve gone on to rally by an average of 16 and 23 percent respectively over the next 50 trading days. The QQQ’s win rate, or positive 50 forward day returns divided by the total, was 91 percent and XLK’s was 100 pct. The only time QQQ failed to generate a positive return in the following 50 trading days after a 3 standard deviation downside move was in March 2022, or towards the beginning of that year’s bear market.

The takeaway here is that history strongly suggests both the Nasdaq 100 and US large cap Tech sector should rally over the next 50 trading days, and by more than 10 percent. This timeframe takes us to around the back half of June.

The March 2022 experience, where the QQQs failed to generate positive future returns, tells us why this time could be different from the usual bounce back for this group. Back then, the Fed raised rates aggressively to reduce inflationary pressures. Because no one knew how high they were going to take rates, or what effect that would have on the US economy, we got a painful bear market. If US trade policy continues to be as unpredictable as we’ve seen thus far, we could get the same result in 2025. 

The bottom line here is that Tech and the QQQs are classic coiled springs, ready to bounce from deeply oversold levels, and only the weight of continued trade and economic uncertainty can keep them from bouncing. If you think trade tensions will ease from here, then these trades make a lot of sense. And, if you believe the worst is yet to come, then Tech is still a sector to underweight. 

Moving on to our second case study of recent extreme moves, here’s a chart of the S&P 500 and MSCI Europe’s 100-day trailing relative returns back to 2015. When the blue line is above the x axis, MSCI Europe outperformed the S&P and vice versa. The solid red line marks the average relative return and the dotted green line marks the 3 standard deviation relative return upside level.

Four quick points here:

The first is that MSCI Europe has lagged the S&P by an average of 3 points over any given 100-day holding period over the last decade. The standard deviation is 6 points, making a 100-day European stock outperformance of over 15 points a 3 standard deviation move.

Second, it’s very uncommon for MSCI Europe to outperform the S&P 500. It’s done so just under a quarter or 23 percent of the time back to 2015.

Third, through today’s close, MSCI Europe outperformed the S&P by 18.3 percentage points in dollar terms, over a 3 sigma move.

Fourth, over the last decade, the only other time MSCI Europe outperformed the S&P 500 by 3 standard deviations over a 100-day holding period was in the timeframe ending January and February 2023. Over the next 100 days, the S&P 500 outperformed MSCI Europe by 4.9 percentage points.

The upshot here is that history says the S&P will outperform MSCI Europe over the next 100 trading days. You really need to think this time is different to believe MSCI Europe can continue to outperform given that it has just done so by a very statistically significant amount and has broadly underperformed over the last 10 years.

Now, here are three reasons why this time could be different.

The first ties back to the Tech trade we just discussed. US Big Tech plus Broadcom is 32 percent of the S&P.By contrast, MSCI Europe has just 2 systematically important Tech names, SAP and ASML, which make up a total of just 4.3 percent of the index. Put another way, Tech is 30 percent of the S&P but only 7 pct of MSCI Europe. That explains why the S&P trades for 20x forward earnings and MSCI Europe only has a 12x multiple. Through this lens, Europe is not necessarily “cheap”, it just has a different makeup of companies.

Second, a stronger euro and pound versus the dollar would help relative returns going forward, given that currency moves are almost half of MSCI Europe’s recent outperformance. MSCI Europe is about 80 percent priced in euros and 20 pct in British pounds.Over the last 100 days, the euro and pound have rallied versus the dollar by 7.8 and 4.6 percent, respectively.The combined influence of euro and pound strength over the last 100 days was therefore responsible for 7.2 percentage points of MSCI Europe’s outperformance through today, or 39 percent of the total.

Third, the European economy would need to outperform over the the rest of this year, no matter if global economic growth is positive or negative. On the one hand, Europe has the edge in terms of fiscal spending. Germany recently approved a 1 trillion euro infrastructure and defense spending package, breaking from decades of post-World War II economic history, whereas the US administration is trying to reduce spending to address deficit concerns. On the other hand, the US has historically had better economic growth and labor force productivity. It also has much more flexible labor markets, which allows it to quickly adapt to economic downturns. Of course, US trade policy and the state of the Chinese economy are 2 important wild cards, and could break either way in terms of its relative impact on the American and European economies.

The takeaway here is that the historical relative return analysis clearly says the S&P should mean revert and outperform over the next 100 days, but macro uncertainties may encourage investors to keep shifting capital away from the US and into European equities over the next few months. The last decade of “American exceptionalism” was based on the market’s confidence that the US economy was robust and capital markets benefited from US companies’ ability to leverage disruptive technology to drive long-term equity returns. While we believe that still applies over the long run, Europe may be able to outperform for another few months as investors move to a more balanced view of each region’s relative strengths and investment merits. We therefore continue to recommend an equal-weight approach to geographic weightings for global equity portfolios, where Europe is approximately 17 percent of the MSCI All Country World equity index.

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