Equity Strategy: Europe and Cross-Regional 2023 Outlook: The International vs US convergence to continue

Speaker: Mislav Matejka, Head of Global Equity Strategy.

Our base case for next year is a recession in Europe and the US, we keep our call for 10% European EPS contraction in 2023. On the positive side, we believe that the rise in bond yields, rise in central bank rates relative to where futures already are, the surge in inflation and the spike in the USD are all likely coming to an end. In addition, as we move through 2023, we will likely see the bottoming out in PMI momentum, as well as a trough in EPS revisions, along with more visible China reopening. These catalysts are likely to ensure that the equity performance, which stands to be pressured by the earnings and activity reset over the coming months, firms up as we move through the second half of 2023. European forward P/Es went from 16x a year ago to 9-11x at the recent low; the P/E compression is unlikely to continue, especially as our rates call is for lower Europe yields from here. Our earnings downside of 10% is smaller than the typical 20-40% seen in past downturns, given better topline, pricing, FX impact, and already enacted cuts. Consequently, we expect higher equity levels at year end than what could transpire in the interim, and net-net have Dec ‘23 index targets above current spot prices. Regionally, S&P500 risk-reward remains relatively unattractive, and we keep our call for convergence, out of the US and into International. We expect this to work in 2023 in USD terms as well, and not just in local currency as was the case this year. Within International markets, UK was our top pick for this year, and we keep our OW on FTSE100 in DM, and a pair trade of OW FTSE100 vs UW FTSE250. At a sector/style level, as we move through the year Cyclicals are likely to anticipate bottoming out in activity, perhaps some time in Q2. In the interim, while the earnings get reset and as PMIs decelerate further, we continue to stay away from the key Cyclicals such as Industrials, Chemicals, Construction, as well as from consumer plays – Autos and Retail. Within Defensives, we keep OW Telecoms, and add to Healthcare (UW to N). The sector did not do all that well in 2022, and could be a good compromise entering 2023. We also add to Utilities (N to OW), where SX6P performed in line with the overall market this year, but will likely have superior EPS growth in 2023, and benefit from peaking yields. Banks (OW to N) have outperformed the broader market this year by 700bp, and we take some profits, on lower yields and continued inversion of the yield curve ahead. We keep long commodity equities for now, despite an already strong run in 2022. Tech could tactically continue to stabilize if our call of peaking yields gains further traction, but it is unlikely to be a sustained leader – we keep our long-term OW Value vs Growth style stance.

 

This podcast was recorded on 30 November 2022.

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