European equities amid maximum uncertainty European equities amid maximum uncertainty European equities amid maximum uncertainty

European equities amid maximum uncertainty

Equities 7 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  In today's equity note we show how European equities are being pushed to new lows relative to US equities as the maximum uncertainty in Europe is driving down equity valuation through the precautionary principle. Equities are about the future of cash flow and if the future has become totally unpredictable then investors must lower valuations on European equities driving up the equity risk premium. European equities are now valued at a 30% discount to US equities but it is still difficult to argue that this is a buying opportunity in European equities. We also cover the agriculture chemicals industry where especially American and Canadian fertilizer producers are reaping massive tailwinds from lower natural gas prices compared to competitors in Europe.


Can you model the future amid the war in Ukraine?

Global equities are only down 11% as of Friday’s close prices despite galloping commodity markets and large scale war on European soil. The probability of a recession has gone and the range of outcomes in the Ukraine war is almost infinite. It is the true definition of maximum uncertainty, which is a huge liability for equity valuations as equities are discounting growth and future cash flows. In its essence the war in Ukraine is the collapse of the future because the future has become so uncertain that under the precautionary principle of risks equity valuations have no other way than to go lower pushing up the equity risk premium.

The war in Ukraine has pushed European equities to a new relative low against US equities measured in EUR total return terms since 1999. It really has been 15 years of hardship for European companies in terms of performance against the US and at one point investors will consider the opposite trade, but in the short-term European equities are too uncertain.

In today’s session we were much lower in European before news came that Russia would cease its war on Ukraine if the Ukraine would make a change to its constitution to ensure neutrality (not entering any blocs such as NATO or EU), acknowledge Crimea as Russian territory, and recognize Luhansk and Donetsk as independent states. These demands are essentially the same as previously communicated by Russia, but the market is relieved sending equities higher because it is being interpreted as an opening for potential peace in Ukraine. Intraday volatility today shows that short-term sentiment is driving everything because “the future cannot be priced”.

Source: Bloomberg
Source: Bloomberg

European equities are now valued at a 30% discount to US equities on a 12-month forward EV/EBITDA which of course reflects that the US economy is better shielded against the fallout from the war in Ukraine. The US has less risks in terms of energy and food security. One thing to note when seeing these European vs US equity valuation spreads is that the US equity market has a much larger share of technology stocks and which has increased over time. The best comparison is to take an entire sector.

If we compare European industrials vs their peers in the US we see that the market was pricing European industrials higher throughout the pandemic indicating that things were improving relatively better for European industrials compared to US industrials. The trade reversed the summer 2021 as the energy crisis in Europe accelerated and the war in Ukraine has blown out the discount to almost 20% again and a new record low. Is it time to buy European equities?

Given the maximum uncertainty regarding the outcomes of the war in Ukraine and sanctions against Russia we believe the most prudent thing is to be overweight US equities vs European equities. However, there are pockets in the European equity market that will do well such as green energy, defense, and mining companies.

Agriculture chemical companies are a hedge amid food crisis

As we have pointed out in several of our latest equity notes, the commodity sector, logistics, cyber security and defense stocks are the themes investors are rotating into. Inside the commodity trade and the energy crisis in Europe, an opaque industry such as agriculture chemicals is doing well. Or the US companies are doing well. Fertilizer prices have exploded higher over the past year due to the higher natural gas prices which is a key input in making fertilizer. However, the increasing spread between natural gas prices in the US and Europe, have given US and Canadian fertilizer producers an advantage over their European competitors which can also be seen in their relative performance. As long as the Ukraine war continues and we have upward price pressure on agriculture crops then this is trade that investors will continue to make. The jump higher in food prices has the unfortunate unintended consequence of potentially creating a humanitarian crisis around food security and this mobilize political forces to end the war in Ukraine as food security is a serious game for any country. The table below shows the companies in the agriculture chemicals industry with a market value above $5bn

Source: Bloomberg
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.