European Equities No Match for Strengthening U.S.

NEW YORK (TheStreet) -- European stocks continue to lag U.S. stocks as the economies' paths diverge.

The Standard & Poor's 500 Index and German DAX stock index continue to move in opposite directions as the U.S. economy improves at a faster pace than before, and euro area fundamentals deteriorate.

The S&P 500 is tracked by the SPDR S&P 500 (SPY) , an exchange-traded fund, and the DAX is tracked by iShares MSCI Germany Index (EWG) .

reading for the Purchasing Managers' Index in the euro area, which was released on Monday, fell to 50.7 from 51.8 for July. The figure came in below a preliminary reading of 50.8, according to London-based Markit.

The index for Germany, the region's largest economy, was 51.4, compared with an  estimate of 52.4, while Italy's index was 49.8, compared with estimates of 51.9.

The decline in European factory activity was largely the result of fighting in Ukraine and uncertainty over sanctions in Russia.

In contrast, Markit said its final U.S. manufacturing PMI rose to 57.9 in August from 55.8 in July, marking its highest level since April 2010.

The chart below shows that in 2014, euro-area manufacturing activity has trended downward, while U.S. manufacturing activity has risen to record levels.


Chart provided by Trading Economics

 

European inflation figures released on Friday provided further testament to weakness in the region.

Consumer prices rose by just an 0.3% annual rate in August, according to official figures released by Eurostat, meeting expectations but marking a five-year low. That was down from 0.4% in July, and is significantly below the central bank's target of 2% growth.

The chart below also shows a divergence of inflation readings between the U.S. and euro area. In 2014, U.S. inflation has risen to an annual pace near 2% as economic growth and labor market conditions have improved.

 

Chart provided by Trading Economics

A divergence of economic fundamentals in the euro area against the U.S. has led to the relative strength of U.S. equities versus German equities during the past year.

Because Germany is the largest and most stable European economy, its equity market will be used as a proxy for European equities as a whole.

The chart below shows a ratio of the S&P 500 over the German DAX dating back to 1990. U.S. equities outperformed German equities during the early 2000s as U.S. financial markets recovered from the crash of the technology sector.

As the effects of the euro, a common currency, took hold, however, the DAX outperformed the S&P 500 during the middle part of the 2000s.

Since the global financial crisis in 2008, the relative relationship of the two equity indexes has traded in a sideways pattern.

  

Data provided by Yahoo Finance

 

U.S. stocks could resume the leadership seen in the early 2000s, however, if the economies continue to diverge at the current pace. Economic releases later this week will speak volumes about the future of the relationship.

On Thursday, the European Central Bank will discuss its view on monetary policy, and on Friday, U.S. nonfarm payrolls will be released.

A way to gain exposure to U.S. strength and European weakness, aside from buying the S&P 500 and shorting the German DAX, would be to buy PowerShares DB US Dollar Index Bullish (UUP) and sell CurrencyShares Euro Trust (FXE) .

If you believe in further U.S. dollar strength, commodities and commodity stocks are likely to be hurt. Selling SPDR Gold Shares (GLD) , United States Oil (USO) , Market Vectors Gold Miners (GLD) and Energy Select Sector SPDR (SLE) could be good trades.

The energy ETF owns Chevron (CVX) , ConocoPhillips (COP) , EOG Resources (EOG) , Exxon Mobil (XOM)   and Schlumberger (SLB) .

The gold miners ETF contains Barrick Gold (ABX) , Franco-Nevada (FNV) , Goldcorp (GG) , Newmont Mining (NEM) and Silver Wheaton (SLW) .

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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