Equity Strategy: The UW on Eurozone vs the US to have a next leg; Stay cautious on China, keep fading stimulus news

Speaker: Mislav Matejka, CFA, Head of Global Equity Strategy

Since the relative high in May to early last week, Eurozone has lost 12% vs the US, in USD terms, and is trying to bounce. We believe there is another leg of underperformance ahead, and reiterate our moving the region to UW two months ago. This was partly given our view that Eurozone activity momentum was about to roll over. Indeed, post the last two months of poor PMIs and other subdued data prints in Eurozone, its CESI is very weak currently, near the typical lows of the range. This could call for some short-term stabilization, but our view is that the Growth-Policy tradeoff in the region is likely to get worse through 2H. The gap between the performance of Eurozone/US equities and Value/Growth style has closed, but the next leg down could be driven by a move lower in bond yields, as well as the earnings disappointments coming up. Earnings and PMIs have a clear link, with downgrades likely at these levels of PMIs. What is at risk in Eurozone? The highest correlation with PMIs is usually seen among Autos and Banks. Banks could still have good numbers in Q2, as NII likely peaks towards the end of the year. We would use any strength on the back of positive results to reduce into. We stay cautious on Chemicals and Mining, despite an already meaningful chunk of underperformance. Capital Goods have been very strong in 1H, but could start to see weakness, as they typically trade with IP momentum. Finally, Semiconductors have near record inventory, many have been outperforming as a play on the AI theme, but the benefit is likely only marginal. The above outcome could be reinforced by any potential further disappointments in China. Now, as MSCI China was already down 20%+ from January highs to the recent low, the stimulus announcements, where the hopes are increasing, could result in bounces, but we advise using these pockets of strength to reduce further. The region is sliding back into deflation and the property market will likely need a much more aggressive policy support to rebound sustainably, given past excesses.

This podcast was recorded on 20 October 2022.

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