Strong ZEW number suggests significant upside in European equities

Strong ZEW number suggests significant upside in European equities by Michael McKenna
Yesterday’s strong ZEW reading suggests European equities will be much higher over the coming months if history any guidance.

Yesterday the ZEW Expectations of Economic Growth Index for September hit 77.4 vs. estimated 69.5 hitting the highest level since May 2000. Given the ongoing uncertainty over Brexit with Boris Johnson’s latest turnaround and resurgence of COVID-19 cases in Europe it seems that Germany’s industry is deriving its positive expectations from a strong economic rebound in Asia which has managed the COVID-19 pandemic much better than Europe.

For the past six weeks the leading European equity index, the Euro STOXX 50 Index, has been trading in a tight trading range, but as we alluded to in our Saxo Market Call podcast today, the strong ZEW number is skewing the probability in favour of an upside breakout. Historically a strong ZEW reading with positive m/m reading has predicted strong returns in the subsequent two months to the release.

66% win ratio and median return of 3.3%

We have looked at all the samples since December 1991 where the ZEW was above 60 and had a positive m/m reading. There are 32 samples in total corresponding to 9% of all ZEW readings. The chart below shows the median path of all 32 samples 42 trading sessions in the Euro STOXX 50 (on a total return basis) prior and after to the ZEW release. As can be seen there is a strong momentum in the European equity market in the months leading into such strong ZEW reading but even more importantly the strong momentum continues in the subsequent two months.

The median path ends up 3.3% after two months and the win ratio is 66%. But even more importantly the interquartile range goes from -2.6% (25% percentile) to +7.2% (75% percentile) indicating a distribution that is heavily skewed towards positive numbers increasing our conviction that the ZEW number yesterday will lead to positive European equities over the coming months.

The number of samples are of course small so the variance in outcome is large. A stronger EUR could also turn out to be a risk to this technical setup in combination with further Brexit uncertainty and surging COVID-19 cases.

Topics: Equities EU50.I Europe

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