Head of Saxo Strats
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.
2024: The wasted year
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Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
