Japan Equities: Defensive Mode
Europe equities not spared from rout
Chief Investment Office, Joanne Goh8 Aug 2024
  • Europe equities were not spared from the recent market selldown despite cheaper valuations
  • After a positive start to the year, the Eurozone economy is showing disappointing growth
  • We expect softer growth conditions to outweigh price concerns, leading to a second rate cut in Sep
  • Escalating geopolitical risks and trade tension further add to the bleak growth outlook
  • Stay defensive in volatile times; focus on tech, healthcare, and luxury for long-term gains
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Turbulent times. The twin headwinds of US labour market weakness and the massive unwinding of yen carry trades sent stock markets plummeting across the board early this week. Despite cheaper valuations, Europe equities were not spared from the rout – the STOXX 600 index hit a six-month low amid a global retreat sparked by concerns of a US economic slowdown, before inching higher as markets showed signs of stabilising. Although rate cut hopes and generally improving investor confidence had fuelled optimism on Europe equities in the earlier half of this year, they continue to trade at steep discounts to US stocks.

Figure 1: Europe equities continue to trade at cheap valuations

Source: Bloomberg, DBS

Growth stuck in flatline. The Eurozone economy expanded 0.3% q/q in 2Q, the same pace as the quarter before, suggesting the economy is recovering from last year’s stagnation. Yet, incoming data has been less inspiring, including weakening PMIs and soft industrial production readings. Economic activity in Germany has been anemic, marked by the 0.1% decline in 2Q despite inflation coming off highs. In contrast, Spain registered a +0.8% q/q increase, followed by France at +0.3%. On the back of higher energy costs, inflation unexpectedly ticked up to 2.6% y/y in July from 2.5% the month before.

Further rate cuts to catalyse recovery. Back in June, subdued economic activity and easing power prices saw the European Central Bank (ECB) taking its foot off the monetary policy brake, ahead of the Federal Reserve. While the region’s economic malaise should warrant further interest rate cuts over the remainder of the year, the mix of tentative growth signs alongside firm inflation poses a dilemma for the next rate review. While the rate reduction in September is not a done deal, our economists expect softer growth conditions to outweigh price concerns and result in the second small cut next month. As banks remain the key source of funding for European companies, further rate cuts will facilitate stronger balance sheets, improve returns for shareholders, and encourage investment activities. Further rate cuts should provide relief to corporates and households.

Earnings muted. Although the year began on a positive note, the current earnings season has not significantly boosted valuations. So far, 58% of companies have reported their earnings, with only 5% exceeding expectations, mainly in the financials, healthcare, and utilities sectors. We are optimistic about the utilities sector which is likely to benefit from lower costs through cheaper oil prices, materials, and lower interest rates, while AI-driven demand is expected to enhance the energy consumption outlook. Financials have surprised positively but growth is weak, and net interest margins are likely to be compressed by further rate cuts. The consumer discretionary sector has been negatively impacted by underperformance in the automotive and selected luxury segments. As a result, the region’s full-year earnings growth forecast for 2024 has been downgraded to 3% with a recovery now anticipated next year.

Maintain cautious stance; stay with resilient sectors. With its strong value proposition, European stocks may demonstrate defensiveness in these turbulent times, but its rebound from the rout may be relatively weak due to the absence of growth. European stock markets have a higher concentration of traditional industries, such as manufacturing and utilities, compared to those in the US. These sectors typically have low growth and low valuation metrics and could serve as safe havens during periods of heightened volatility.

In the long term, we favour the IT, healthcare, and luxury sectors in Europe which are poised to benefit from structural demand trends. The IT sector is set to thrive with the accelerating global adoption of AI, while the healthcare sector will gain momentum from the rising number of medical solutions aimed at enhancing the quality of life. Luxury is a long-term structural growth sector poised to benefit from increasingly affluent populations. In particular, given surrounding uncertainties, demand from ultra-high net worth spenders for quiet luxury brands is noteworthy as the demographic is less price-sensitive and bolstered against economic downturns.


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