European equities took a hit after last week’s ECB meeting, but sentiment has been turning more bearish for the last few months and Morgan Stanley’s market timing index (MTI) based on a collection of sentiment metrics is now at the lowest level in two years and fully in Buy territory.
“Price action suggests that markets appear to be experiencing a growth/deflation scare at this time even though economic surprise indices are not breaking down and US 2Y yields remain resilient,” write Morgan Stanley analysts Matthew Garman and Krupa Patel. “We believe that the growth outlook isn’t as bad as feared… although not every metric is at ‘must buy’ levels, our indicators provide a relatively broad-based message of pessimism.”
Sentiment low – European hedge fund net exposure near two-year lows
Both individual investors and the smart money seem to be taking a step back from Europe right now. Long and net European hedge fund exposure is close to its lowest level in two years, while September saw the biggest net outflow from European ETFs (including those domiciled in the US and Europe) since April 2012, reaching $5.3 billion. Garman and Patel point out that large outflows from a few specific ETFs skew the average, but argue that this should still be read as a general sign of shifting investor sentiment.
Sentiment – Volatility is moving towards a Buy signal
Volatility indices aren’t quite signaling to Buy, but Garman and Patel say they are moving quickly in that direction. The put/call ratio recently hit 1.3, rising above the 1.2 level that they consider a Buy signal, but the 15-day moving average is still around 1. Similarly VSTOXX has reached 21.1, just under the 22 level that they argue has been a good Buy signal for the last two years. The VIX is the exception here because it has only reached 17, while Garman and Patel consider it to signal a buying opportunity around 20, and the 15-day moving average is still below 15.
European technical indicators also depressed
MSCI Europe has fallen below its own 12-month moving average for the second time in recent months, but it is still only just below. It hasn’t moved a full standard deviation below that level since 2012 and it hasn’t moved two deviations below since 2011, so it’s still too early to say that it is going to break well below trend. Six month price momentum on the other hand has turned negative for the first time in two years, which could be a signal of greater weakness than the previous price drop.