Equity Strategy: When to close the preference for Europe over the US? Q1 results still to be better, but don’t extrapolate

Speaker: Mislav Matejka, Head of Global Equity Strategy

Regionally, we are OW International equities vs the US, and within this specifically Europe vs the US, a position we held through 2022 and so far ytd. The question is when should one close this trade? Internal leadership might become increasingly difficult for Europe to keep beating the US, especially if our call of Value underweight this year, and the recently introduced preference for lower beta part of the market - where we in particular cut Autos, and added to Staples - keeps gaining traction. So far ytd, Value is behind in both Europe and in the US, and the Defensive stocks are staging a recovery - Eurozone has historically been more of a Cyclical Value tilted play. The big benefits for Europe that we were highlighting in Q4, of falling gas price and the China reopen, are now in the open. Eurozone has enjoyed a strong rebound in PMIs since November on the back of these, of 7 points, but the upmove could be petering out soon. We note that Eurozone valuations vs the US continue to screen cheap, but it appears that the consensus call these days is to be OW Europe vs the US, and the region has strongly outperformed in the past few quarters. Eurozone is up vs the US by 31% in USD terms since the September low. We are remaining OW Europe vs the US, for now, but think that the time to take profits on the trade is approaching. Looking at Q1 reporting season, the consensus expectations have come down aggressively over the past months, from +7% yoy for S&P500, to current -7%. In contrast, activity in most places was better in Q1 vs the previous quarter. The combination of low hurdle rate and the improving fundamentals bodes well for the corporate results, where we expect beats. Having said that, the beats might not lead to upgrades for the rest of the year. 2023 projections keep moving lower. Also, the question is whether the stocks will rally much further on the back of beats, post an already strong rally. We advise to use any strength on the back of positive Q1 results as a good level to reduce from. Finally, consensus expectations are for a renewed margin acceleration in 2024, which could prove too optimistic, as pricing normalizes.

 

This podcast was recorded on 24 April 2023.

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