Head of Equity Strategy
Summary: European equities have been split into two parts with the energy and defensive sectors holding up well while consumer discretionary, real estate, and information technology stocks have been hit hard this year from higher interest rates and galloping energy costs. We remain defensive on equities overall, but in our equity note today we highlight the themes we like including the equity factor quality which we believe will see less margin compression than the weaker companies with less strong balance sheets and operating metrics.
Investors are running away from real estate, IT and consumer discretionary stocks
European equities are down 12.1% this year which given an economic slowdown and historic energy crisis pushing up cost-of-living is quite acceptable. One reason why it has not been such a bad year after all, is that the energy sector is 35.5% this year and the European equity market is heavy on consumer staples and health care stocks which have also done well. Despite some utilities are being thrown a lifeline by European governments, the overall utility sector has held up well offering its defensive qualities.
The real damage this year has been in real estate as yields have surged pushing up mortgage costs. Quite stunningly, the European real estate sector is now down 24% over the past 5 years offering no income for its investors. With financial conditions set to tighten significantly from here to cool down inflation the sector is likely going to face more headwinds. The IT sector is still interest rate sensitive through higher bond yields and the share price declines have put pressure on operating costs as the value of employee stock options has fallen. Finally, the consumer discretionary sector is hard hit by the cost-of-living crisis as we also described in our recent equity note Consumer stocks to be hit by historically high energy costs.
Regular readers of our research will know that we are still positive on commodities with energy being the main driver of returns and other tangible-driven themes such as defence, logistics, and renewable energy. Across equity factors we urge investors to seek defensive characteristics in high quality companies as they will be forced to eat less into their operating margins than the weaker players in the different industries. The 10 largest holdings in the iShares Edge MSCI Europe Quality Factor UCITS ETF are listed below. These names are not investment recommendations, but simply names that are part of the quality theme, which can be defined in many ways. One main risk for the quality factor is that these stocks come with high equity valuations and thus are a bit more interest rate sensitive than the average European stock.
Finally, it is important to reiterate our base case scenario. We remain defensive and expect the global equity market to correct around 33% from its peak before we have found a bottom. This view is driven by our view that inflation will be structurally higher than in previous periods due to deglobalization and operating margins will come under pressure from higher wages and higher yields.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
