OVERVIEW
THE BIG PICTURE
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European citizens and equity investors will be happy to turn the page on 2020. Quite possibly we will be turning many pages in fact: that of COVID (we hope), the UK in Europe (we think), perhaps also the outperformance of defensives, the strong US dollar, falling bond yields, high dividend yields, carbon in portfolios etc. Three years ago we turned cautious on European equities, the STOXX 600 Index was at 387 points. Three years later, with the STOXX 600 at the exact same level, we say goodbye to our bear positioning.
Will 2021 be a good year for European equities?
In their latest report "European Equity Market 2.0", our strategists highlighted some structural changes in the European Equity markets: the pooling of interests with the EU recovery funds, a new long-term strategy for Europe with the green deal, and major changes in the market structure. Looking ahead, they are constructive on European equities, and discuss three catalysts that could support European equities into 2021:
Will the rotation toward cyclicals continue?
Following the news on the vaccine, the market is showing a lot of enthusiasm and, like a rising tide lifting all boats, all the laggards have rebounded and now some of them are already pricing in strong growth expectations. Looking ahead, the market is likely to be more selective and companies with structural issues may be left behind. Our strategists favour cyclicals names related to government spending (green, digital and traditional infrastructure) over consumer-oriented sectors.
Turning the page
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This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
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What are the main market risks?
Our strategists look at the market risks that could be a headwind for our European equities rally. They identify two risks: bond yields and EUR strengthening.
1) a COVID vaccine - Europe is the epicentre of the second wave and thus COVID continues to weight on its economy. Except Utilities, all the European sectors have underperformed their global peers. Most of them are trading with a discount. A vaccine would therefore be a catalyst for European equities.
2) Monetary and fiscal support at work - European leaders agreed this summer on EU recovery funds, which the various countries still need to vote on. Thus, the money has not yet been injected in the system. Fiscal support on top of still accommodative monetary policy from the ECB should offer European equities a supportive policy mix next year.
The recovery path looks bumpy in Europe in the coming months. Indeed, we cannot rule out a third wave before the vaccine is fully deployed, unemployment and default rates could increase, and implementation of the EU fiscal support could be delayed. However, the market should continue to price in the fact that the European economy
is still on the road to recovery. Therefore, European PMIs are expected to remain overall over 50 into 2021 and thus cyclicals have room to outperform defensive sectors.
Rising bond yields could hurt long duration stocks. Those stocks have been the best performers over the last few years and thus taken on significant weight in equity indices, meaning they could come under pressure if bond yields increase. The lack of inflation (to date) as well as very accommodative monetary policy in both sides of the Atlantic should prevent bond yields from increasing too much above the current level. Nevertheless, the greater need for financing on the public side should increase the supply of government bonds.
ACCEPT
Cyclical issues should pass, but structural issues will remain. Many of this year’s underperformers have been underperforming for a couple of years. With the COVID vaccine ramping up and an economic recovery underway, we may see the gap between “new” businesses and “old” businesses close somewhat in the short term. Damaged sectors could quickly get back to where they were at the beginning of the year but the structural challenges they faced would come back, capping their recovery.
While the timing and magnitude of a weaker dollar remain uncertain, the prospect of the Fed staying super-easy through the winter and beyond, along with optimism on the vaccine, are bearish for the dollar. For equities, the forces behind the EUR/USD moves are important. In the past, the euro has often strengthened when the eurozone economy improved, and inversely, it has weakened when the economy was slowing down (a positive correlation).
Eurozone Manufacturing PMI
above 50 (showing economic expansion) would support an
outperformance of cyclicals over
defensives in Europe.
European cyclicals have been the most impacted by the COVID-19 recession and should thus benefit the most from the recovery.
Basic Industries and Industrials 12-month trailing EPS are respectively down by 28% and 41%.
European Cyclicals vs Defensives and Eurozone Manufacturing
European Cyclicals & Defensives earnings per share
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ACCEPT
All lights are green for Eurozone small caps, and they may benefit from several tailwinds:
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This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
© Societe Generale 2020
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3) Positioning is very weak - European equities have continued to suffer from heavy outflows this year. Therefore, the positioning on European equities is getting weaker in global investors’ portfolios. Investors could reposition on European equities at a time when US equities and Big Tech volatility are pushing investors to look for alternatives and portfolio diversification.
What Brexit and the German elections could mean for the market?
At the time of writing, discussions and negotiation between the EU and the UK are still ongoing. Obviously, Brexit would have a price tag in any case, deal or no deal, mostly for UK growth but to a lesser extent for EU growth as well. However, it could also bring some visibility for global investors on what the new Europe excluding the UK would look like. A completed Brexit could support inflows back into European equities.
Like most of European markets, the UK equity market has also suffered from a COVID-19 second wave. The relative valuation of the FTSE100 index compared to US equities is back at an all-time low (a 33% discount). Nearly all UK sectors are trading at discounts to their US counterparts. The rebound following vaccine announcements should help the UK market to recover. A deal would obviously be a short-term catalyst, but in the event of no-deal, the FTSE100 (full of exporters) would benefit from a weak currency.
As for the German elections, our economists have highlighted that the contours of next year’s crucial federal election are gradually emerging. According to the current polls, the current Grand Coalition would maintain a majority of the seats in parliament, even if the Green party were to become the second biggest party. With or without the Green party in the next election, our strategists expect continued fiscal support in Germany and a pro-EU stance in terms of foreign policy.
Nearly all UK sectors are trading at discounts to their US
counterparts. The main exceptions being Pharma and Diversified Financials.
UK vs US sectors – 12-month forward P/E ratio
Opinion polling for the 2021 German federal election
Following the health crisis, Merkel’s CDU/CSU is leading in the polls. The Greens are the second party.
2) Monetary and fiscal support at work - European leaders agreed this summer on EU recovery funds, which the various countries still need to vote on. Thus, the money has not yet been injected in the system. Fiscal support on top of still accommodative monetary policy from the ECB should offer European equities a supportive policy mix next year.
What Brexit and the German elections could mean for the market?
Following the news on the vaccine, the market is showing a lot of enthusiasm and, like a rising tide lifting all boats, all the laggards have rebounded and now some of them are already pricing in strong growth expectations. Looking ahead, the market is likely to be more selective and companies with structural issues may be left behind. Our strategists favour cyclicals names related to government spending (green, digital and traditional infrastructure) over consumer-oriented sectors.
The recovery path looks bumpy in Europe in the coming months. Indeed, we cannot rule out a third wave before the vaccine is fully deployed, unemployment and default rates could increase, and implementation of the EU fiscal support could be delayed. However, the market should continue to price in the fact that the European economy is still on the road to recovery. Therefore, European PMIs are expected to remain overall over 50 into 2021 and thus cyclicals have room to outperform defensive sectors.
Cyclical issues should pass, but structural issues will remain. Many of this year’s underperformers have been underperforming for a couple of years. With the COVID vaccine ramping up and an economic recovery underway, we may see the gap between “new” businesses and “old” businesses close somewhat in the short term. Damaged sectors could quickly get back to where they were at the beginning of the year but the structural challenges they faced would come back, capping their recovery.
Eurozone Manufacturing PMI above 50 (showing economic expansion) would support an outperformance of cyclicals over defensives in Europe.
European Cyclicals vs Defensives and Eurozone Manufacturing
European Cyclicals & Defensives earnings per share
European cyclicals have been the most impacted by the COVID-19 recession and should thus benefit the most from the recovery.
Basic Industries and Industrials 12-month trailing EPS are respectively down by 28% and 41%.