OVERVIEW
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It seems that in just a few months the European equity market interface has totally changed. Exit the old dogmatic way of thinking, where debt and deficit were the only metrics monitored by governments, and welcome to European fiscal support, (some) debt mutualisation and a long-term strategy plan to save the planet from global warming. Recent sector performances accelerated overall market exposure somewhat: more growth and high quality names, fewer structurally challenged industries (energy, banks, telecoms). This new version of the European equity market should be much more attractive in the eyes of global investors, in our view, which is perfect timing, since they have plenty of cash to invest.
European equity market 2.0:
higher growth prospect, lower dividend yield
The European market has suffered from its sector exposure. Indeed, the weight of “old” sectors, such as Banks, Energy and Telecom has been significant in the European index. A decade ago, following the Great Financial Crisis, which hammered the banking sector, these three sectors still accounted for 31% of the Stoxx600, almost double the exposure of the US market to these sectors (17%). In short, the European market ran the bull market race with dead weight... and lost. However, the strong divergence in sector performance in Europe has gradually rebalanced the region’s sector exposure in favour of leader, growth and quality sectors.
A new long-term strategy for Europe: the Green Deal
The Green Deal is the Europe’s new growth strategy. It will be at the heart of the EU recovery fund. It is not only an economic and political project. The latest Eurobarometer survey shows that environment and climate change are among European citizens’ main concerns.
European equity market 2.0
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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 is next for European equity indices?
The coming months will be driven by how the economy responds to fiscal support, the US elections and newsflow on a vaccine. All in all, volatility is likely to remain, and our strategists expect European equity indices to trade around current levels.
The COVID-19 pandemic and market drop this year has accelerated this trend. Today, Technology, Health Care, Personal & Household Goods, and Industrial Goods & Services now account for almost half of the European index (46%). By contrast, Banks, Energy and Telecom have more than halved in size in the past ten years and now make up only 13% of the STOXX600 index.
This change in index sector weights is likely to have consequences at the index level, including potentially higher growth expectations, which means higher valuations. It may also mean structurally lower dividend yields, as growing companies with high profitability tend to invest rather than redistribute to shareholders.
It is also becoming a key factor for investors, as shown by the strong inflow into ESG funds. With the Green Deal, Europe wants to accelerate its energy transition, and at the heart of this is the goal of becoming the world’s first climate-neutral continent by 2050. This is an opportunity for European companies to develop skills and knowledge, which would allow them to potentially export their expertise around the globe.
Inflows will probably return for European equities at the start of next year, before the spike in defaults and credit spreads expected in 2Q and 3Q next year puts pressure on risk assets. Thereafter, the political agenda should continue to be a source of volatility, with the German elections in October 2021, the French elections in May 2022 and potentially more Brexit negotiations if politicians push the exit date further out again.
ACCEPT
Our Societe Generale strategists have designed a European Green Deal basket of 43 European companies that could potentially benefit from the Green Deal and help the EU to achieve its ambitious target. This basket of stocks has risen 73% over the past two years, strongly outperforming the STOXX 600 (by 71%) and its major peers (ETFs and indices labelled “Clean Energy” or “Climate change”). With the Green Deal ready to take off, the earnings growth outlook for the basket looks strong, and they believe now is a good time to gain exposure to the European Green Deal theme. Please click here for more information on the European Green Deal.
an economy still in recovery mode with PMI above 50
valuations (12% premium on forward P/E vs average 26%)
small caps have deleveraged and balance sheets are sound
massive fiscal and monetary stimulus
The global economy is still in a recovery mode. In the euro area, SG economists forecast GDP to growth 4.8% in 2021. In the short term, fiscal and monetary support are still at work and should support the ongoing recovery. The recent PMI rebound has supported our strategist's call last quarter to add more cyclicals to the portfolio.
All lights are green for Eurozone small caps, and they may benefit from several tailwinds:
OUT OF THE BOX
Any newsflow regarding the potential success of a vaccine has been welcomed by the market. Our strategist believe if a vaccine were widely authorised in major developed countries as effective against the Covid19, it would be welcomed by the market and would somewhat help the risk premium to normalise.
In term of sectors, the most sensitive to such news would be Hotels, Restaurants & Leisure. Indeed, these stocks have been hammered by the pandemic and its consequences (lockdown, social-distancing, etc.). IBES long-term growth expectations for the sector moved from doubledigit growth directly into negative territory in just a few weeks. Other sectors like beverages, retail, commercial real estate, airlines and aircraft-makers would also welcome such news.
What if we get a vaccine?
Our Equity Strategists have identified a basket composed of 14 "Fallen Angels" to get exposure to a scenario in which a vaccine is coming. These companies used to be considered as “Stars” (quality names with good long-term prospects), as they were all trading at higher multiples than the market. They offer much more value today as they have dropped on average by 35% ytd. Hence, a lot of bad news is already priced in, suggesting some level of capitulation. They believe this basket offers an appealing asymmetric risk profile and would benefit from any newsflow on a vaccine. In August, the basket gained 13% versus 3% for the STOXX600 index. Full details about the basket composition can be found in the full publication "European equity market 2.0"
The cumulative weight of Energy, Banks and Telecoms has declined by two-thirds over the past 15 years, in favour of sectors such as Technology, Health Care, Personal & Household Goods and Industrials.
This trend has accelerated in the past two years.
We no longer see any Energy,
Banks, Telecoms or even Basic
Materials in the top 10 market
capitalisations.
Top10 is now composed of three
technology companies and three Health Care companies.
Sector exposure of European equities over the past 15 years
Top 10 market capitalisations in STOXX600: today versus 10 years ago
Cyclicals tend to outperform
Defensives in Europe when the
Eurozone manufacturing PMI
remains above 50.
European cyclicals vs defensives and Eurozone Manufacturing PMI
MSCI EMU small caps vs large caps and Manufacturing PMI
The following reasons tend to favour small caps versus large caps: the Eurozone recovery exposure, the strengthening of the EUR, the ample liquidity, as well as the valuation and balance sheet angles.
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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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