Stocks and bonds don't always move together, and our recent experience with the
divergence from other indices tells us stocks and stocks don't always move together, either. That's not only true in the U.S., but in Europe now as well.
Too much bond buying now is of the white-knuckle variety, which is a shame because bonds have an important role in everyone's asset allocation mix. This "flight to quality" response -- and does this imply we flee from quality given the chance? -- shows up throughout the world of fixed income. When the going gets tough, the tough sell anything with risk and buy Treasuries.
If we look across the Atlantic, we also find investors buying British government bonds, or gilts, against German bunds. This is a stark reversal of recent European history: For most of the past quarter-century, the mark and Swiss franc, along with bunds, were the repositories of scared money in Europe. The introduction of the euro, however, has changed a lot of old habits.
British And German 10-Year Government Yields
All Right, Don't Sink The Bismarck!
At the same time the gilts and the British pound (GBP) are performing well relative to the bunds and euro (EUR), we find the German
, that nation's principal stock index, doing quite well relative to the British
. The divergence between the two indices is not quite as extreme as that of the Nasdaq and either the
, but it is still quite pronounced, and is rather confounding given the currency and interest-rate environment.
Relative Movement: German & British Stock Indices
The four strongest performers in the DAX so far during 2000 have been
, an electronic components manufacturer;
, the enterprise software giant;
, another electronics firm; and
. The FTSE, not to be outdone in the technology department, has been led by
, a computer service and software firm;
Cable & Wireless
, a telecommunications giant;
, a consulting firm;
, a media giant;
When technology stocks are the hot performers worldwide, and these issues are found in abundance on the FTSE, why is there such a divergence between the DAX, up 8.23% in dollar terms at the time of this article, and the FTSE, down 13.19% in dollar terms so far in 2000?
The answer, as we have seen so many times before, is weights. The DAX has 30 members, with the four leading technology-related stocks mentioned above accounting for 43.10% of the index. The FTSE 100, with its 101 stocks, (and remember, these people assembled a pretty decent empire in their day) has a much more diverse distribution, with only
, at 15.38%, accounting for a disproportionate share.
Moreover, the FTSE has a much greater representation of financial stocks than does the DAX, and the financials aren't doing any better over there than they are here. FTSE laggards include insurance companies such as
, and banks such as
Royal Bank of Scotland
. DAX laggards include auto manufacturers
, and heavy manufacturers such as
, the sporting goods and apparel firm.
In the event of a role reversal between the DAX and FTSE, guess which group of laggards will respond better in a slowing economy to a relative relaxation of monetary policy?
Bank of England to the Rescue?
The rally in the gilts, the strength of the GBP and the weakness of the financial sector in the FTSE all stand as evidence of an overly restrictive monetary policy and unnecessary economic weakness in the U.K.
before that the
European Central Bank
might start to feel some heat over the soft euro (EUR), and indeed, the ECB raised rates by 25 basis points on Feb. 3, with a Fed-like warning of further potential increases. The upward rate path in Euroland is unlikely to be matched in the U.K., leading to a further softening in the GBP/EUR cross, as seen below.
British Pounds Per Euro
These diverging policy paths and converging note yields are ringing the bell for the complex macroeconomic trade noted last month: Buying the EUR/selling the GBP, and buying the FTSE/selling the DAX. Pros also will be looking to sell the gilts and buy the bunds. The signal for launching these trades will be a policy announcement from the
Bank of England
regarding interest-rate harmonization with the rest of Europe.