- Whether the vantage point is the economy, the political landscape or Covid-19, Europe appears to be in better shape than the US
- EU member states’ endorsement of the Franco-German led EUR 750 billion recovery fund last month and the ECB’s continued monetary stimulus put the European economy on a much firmer footing
- Crucially for investors, Europe’s stock markets do not yet discount the region’s improving economic prospects
Markets have rallied sharply on unrelenting policy stimulus, but Covid-19 has yet to be defeated. Fears of a second wave and mounting political risks argue for investor caution. Below, Pictet Asset Management (Pictet AM) shares their views on Equities regions and sectors:
Europe shines but time to cut back on financials
Whether the vantage point is the economy, the political landscape or Covid-19, Europe appears to be in better shape than the US. Which is why Pictet AM retains an overweight position in European stocks. EU member states’ endorsement of the Franco-German led EUR 750 billion recovery fund last month and the ECB’s continued monetary stimulus put the European economy on a much firmer footing; Pictet AM has consequently raised their forecast for the region’s GDP growth for 2021 by 1 percentage point to 7 per cent.
Crucially for investors, Europe’s stock markets do not yet discount the region’s improving economic prospects. Particularly when compared to their US counterparts. At current levels, the gap in US and European price to book ratios (3.7 vs 1.7) implies American corporations’ return on equity will further outpace that of European firms, widening from a differential of 5 percentage points to over 10 percentage points. Such an outperformance looks highly unlikely.
US stocks are already very expensive in any case. For US equities to maintain their current price-earnings multiple of around 24, corporate profit margins would have to remain stable. That is a stretch, particularly when factoring in the US’s continued failure to contain Covid-19, the growing regulatory backlash against Silicon Valley and uncertainty surrounding the outcome of the November Presidential election. Mindful of these risks, Pictet AM remains neutral US stocks.
With an increase in consumer spending a feature of the recovery taking hold in parts of the world, Pictet AM is attracted to consumer staples stocks. The sector has failed to keep pace with the broader market rally, which has been led by cyclical stocks. As Fig.3 shows, consumer staples trade at just a 10 per cent premium to the broader global market – down from over 20 per cent in March and the 10-year average of 25 per cent. Consumer staples companies' improving earnings growth suggests their stocks warrant a higher premium.
To maintain a defensive tilt in their equity allocation, Pictet AM has reduced their weighting in financials to underweight. Although banks’ bad debt provisions resulting from pandemic-induced lockdowns have been largely in line with expectations, they remain acutely vulnerable to any setback to the smooth reopening of economies.
Moreover, dividend payments are unlikely to recover for the foreseeable future. Regulators across the world– including the ECB, the Fed and the UK’s Prudential Regulatory Authority – have moved aggressively to either cap bank dividend payments or temporarily suspend them. This greatly reduces the investment appeal of financial stocks.
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