by Alexandra Lienhard
Updated: August 11, 2017
Watch the editor of our monthly European Financial Forecast, Brian Whitmer, explain how one factor (hint: it ain't pessimism!) is driving trends across Europe -- and what it implies for your investments.
Alexandra Lienhard: Today I'm joined by Brian Whitmer, who is the editor of Elliott Wave International's European Financial Forecast, and contributes to the monthly Global Market Perspective. Hi Brian, thanks for taking a couple of minutes to chat today.
Brian Whitmer: Hello, Alex. Nice to be here.
AL: Now, Brian, you start off the latest issue of the European Financial Forecast by focusing on tech right off the bat. So why was it front and center this month?
BW: Yeah, I'm focused on tech, really because this sector displays all of the things that we look for, kind of leading up to a reversal. The main thing we focus on obviously, is Elliott Waves. We can see the structure here. In a lot of different indexes I'm showing here, the STOXX 600 Technology Index, this is back to the '09 lows here. And we just have this really pretty textbook, five-wave advance, we've got a wave one, two. We've got a nice third wave here. We've got a real textbook triangle there. And where that puts us is in this fifth and final leg to new all-time highs. Now, the biggest sign that a sector is overheating is when really, the optimism starts surging ahead of fundamentals. And I think we're definitely seeing that in European tech now. We've got venture capital funds, we've got money just pouring into those, we've got, I don't know if you've heard about Station F in Paris. It just opened last month, biggest technology startup incubator in the world now. These are the kinds of projects that come about at the tail end of an uptrend. We've got government getting involved now, especially in France. Macron wants to turn France into a startup nation. He's got a $10 billion public fund to fund technology startups. These are all the telltale signs that this is a late stage rally, and that optimism is just overflowing.
AL: Now, Draghi has been front and center this summer, given the expectations that the European Central Bank would announce when it plans to roll back its stimulus. But you actually argue that bond spreads have gone in the opposite direction than they should have, given expectations surrounding the ECB. So can you explain that?
BW: Yeah, I'm always fascinated when markets move against the popular narrative. And right here, the narrative is that look, Draghi is going to end this stimulus program. He's going to stop purchasing these bonds at some point. Whether it's this quarter or whether it's next quarter, this stimulus program is going to end. And the view is that that knowledge should be sending spreads really soaring, especially in peripheral Europe, which is most affected by this bond-buying program. But it's just not really what we've seen. If we look at spreads between Italian and Spanish debt with German debt, the top line is Italian debt here. And we just hit a... this is about a two-month low in this spread. So the spread was widening in 2015 and 2016, but it has come back quite a bit. If you Look at Spain, that spread just hit a two-year low against German debt. So again, I don't think what's driving the bond market right now is Draghi's action or inaction. I think what's driving this is complacency. We're seeing the same thing in bonds that we're seeing in stocks. And I think this is another dangerous market to be buying right now.
AL: And investor complacency is actually something you've been stressing, not just in the latest issue of the European Financial Forecast, but in many of your recent letters over the last 12 months. And you still believe that this is an enormous tail risk for the markets. Why is that?
BW: If I had to pick one factor that I think is driving most of today's financial trends, I think it's complacency. Investors are optimistic. They're optimistic that stocks are going to continue higher. They're optimistic that the economy's going to continue improving. And as such, they're willing to own debt in the weakest economies in Europe just to achieve some kind of yield. And we're seeing the same complacency in the junk bond market. We're really seeing the same complacency in things like credit default swaps, which are kind of an insurance contract against default. I showed an index last month from market of CDS rates on senior financial debt. The thing to notice about this chart is when there is a lot of fear in the market, it costs investors a lot of money to insure their bonds against default, because everybody expects them to default. When there's a lot of complacency in the market, the cost of insurance becomes really cheap. And that's exactly what we're seeing. Really, we've been seeing that since 2014. And we just fell to the lowest level now. I think this is the lowest since January of 2008. So just before the biggest credit crisis in a generation, we're showing those levels of complacency today. I think this really kind of confirms what we think we're seeing in the wave structure in stocks, which is that we're reaching a peak here in optimism.
AL: And Brian, what will turn first — stocks, credit, or spreads in your view? Stocks first. I think the stocks are a leading indicator of social mood. I think they start to trend down, and after that trend has been established, then you're going to start to see stress in the credit markets. Then you're going to start to see that kind of waxing negative social mood show up in things like politics and current events. But definitely the stock market is the best leading indicator of mood.
AL: Brian, thanks for talking today. Certainly a lot to keep our eye on over in Europe.
BW: Hey, thanks for having me, Alex.