Key Points

1. Factors that still support our Positive Equities view include a) falling energy prices and inflation rates; b) better-than-expected economic momentum as consumption holds up well; c) a rebound in global liquidity (represented by the global M2 money supply), and d) stable to lower long-term real bond yields.

2 .Improving market breadth suggests rebound can continue: our favoured indicator of stock market breadth, the number of index components above their own 200-day moving averages, gives a clear bullish signal for the majority of stock market indices, in Europe and also now in the US.

3. Favour World ex-US stocks over US, equal-weight within US: we prefer to invest in the UK, eurozone, and Emerging Market regions (including China) given improving economic momentum, low valuations and resilient European earnings forecasts. We remain Neutral on the US, preferring mid-cap and equal-weight equities exposure.

4. Buy backs have reached a 14-year peak. This shows the confidence of many companies that their stock price is cheap and their balance sheet solid enough, with excess cash to invest in their own shares.

Key Recommendations

(+) Positive globally on the Value factor: Growth stocks posted 118% outperformance versus Value stocks from 2007 to August 2021. Since then, Value has rebounded vs. growth by 32%. But given the scale of the rebound of Value against growth from 2000 to 2002, and from 2003 to 2007, we believe value may have a lot further to run. Favour sectors, funds and ETFs focused on Value stocks, including higher dividend strategies.

(+) Cash flow-rich value sectors still favoured: choose companies with strong cash flows and balance sheets. In this regard, Energy, Financials and Mining sectors are currently the best.

(-)  Consumer Staples downgraded from Neutral to Negative: latest results and forecasts show that pricing power is diminishing at a time operating profit is under pressure due to rising costs. P/E ratios above 20 are now difficult to justify considering that 2023 EPS growth could be nil.

Key Risks:  the US Federal Reserve continues to raise interest rates post the February FOMC meeting, triggering  a deeper economic slowdown. A larger sell-off in housing markets could weigh on consumption.

1. Equities Outlook

Keeping the faith (positive) in stocks

One month into 2023, investors have already recovered quite a bit of the ground lost last year. Eurozone and Chinese stocks have led the advance, gaining 10% and 9-12% respectively since the start of the year (as at 30 January). Corporate credit has also participated in this risk rally, gaining 4% year-to-date.

Eurozone defies recession, for now: The indirect benefit to European exports from China’s reopening, combined with the sharp retracement lower in European natural gas and electricity prices, has inspired a sharp improvement in eurozone economic momentum. This is reflected in the rise in both manufacturing and services purchasing manager (PMI) survey readings for January, which rebounded to around the 50 break-even level between expansion (growth) and contraction.

US economy remains a puzzle: on the one hand, falling Lead Economic Indicators clearly point to a looming recession. On the other, a surprisingly strong January ISM Services PMI (New Orders at 60!) and strong January employment payrolls suggest, if anything, a pickup in the Services sector. On balance, we maintain our expectation of a modest recession in late 2023 or early 2024, despite growing expectations of a soft landing by sell-side banks.

World ex-US Equities (Positive): we upgraded Equities overall to Positive on 12 December 2022, with a focus on World ex-US equity exposure (we remain Neutral on US Equities) and on the Value style (low valuation, high dividend yield) within Equities. Since this upgrade, the MSCI World ex-USA index rebounded 7% in US dollar terms and 4% in euro terms (to 26 January).

Key regional preferences such as UK stocks (FTSE 100) have risen 4% in sterling terms, while the Euro STOXX index has gained 6% in euro terms over this period.

Liquidity, technicals and investors’ positioning are supportive, as shown in the next few slides.

2. Technicals are improving fast 

The equity rally is broadening

As shown before, the January rally was propelled by short covering, with those stocks having recorded the worst performances in 2022 rebounding the most (in general : low quality names). Now, remember that if stock ‘x’ drops 50% in year t and then rebounds by 50% in year t+1, stock ‘x’ is still down -25% compared with year t-1.

Encouragingly, technicals are getting much better: many strong resistance levels on key indices (Europe, S&P 500 and, more recently, on the Nasdaq) have been broken. Another key indicator of breadth of the market (percentage of stocks trading above the 200 day MA) also confirms that one should hold a high equity exposure. 

If you don’t buy stocks, companies will buy them (back)!

Buybacks have reached a 14-year peak. This shows the confidence of many companies that their stock price is cheap and their balance sheet solid enough, with excess cash to invest in their own shares.

Bank of America explains that among 220 different global strategies they follow, a portfolio composed of stocks of companies heavily buying back their own shares performs among the best, with also a lower risk/ volatility. This is a supporting argument of our current preference for the (cheap) energy, financials and healthcare sectors as massive buybacks are taking place in these sectors. 

3. European stocks are investable again!

ABUNDANT outflows from European equities in 2022;

this trend is now turning around

2022 spooked many investors out of European equities due to the conflict in Ukraine, the energy crisis and the global economic slowdown, supposed to affect the European economies relatively more, due to their open nature. Outflows from this asset class were abundant. With the energy crisis more under control and China’s economy recovering, the European economy is showing resilience (recent ‘economic surprises’ have been much more positive in Europe than in other parts of the world). Inflation and bond yields are falling and valuations are cheap in Europe. All these factors support our view that it is time to revisit European equities, with a preference for the highly discounted Value/Cyclicals.

European earnings show resilience

The energy crisis in Europe was supposed to lead to a collapse in European consumption and corporate profits. This is what could often be read in the gloomy strategy research circulating in 2022. We were not as pessimistic as our peers because we estimated that economic fundamentals were not that bad: Western economies were close to full employment, savings were abundant in the COVID era and balance sheets look very solid, including those of banks. On top of that, the weak EUR/USD helped European exporters. Therefore, earnings growth has been much better in Europe (+18.2% is expected in 2022) than in the US (+6.4%). In the meantime, the valuation gap between Europe and the US is still very high. 

4. Pricing power has its limits

In the us, earnings released so far show continued pressure on operating margins

After several quarters of excellent profitability and fast-rising prices, the question was how long companies could maintain their very high profit margins. Pressure started last year but excess savings allowed consumers not to worry too much about rising prices. After two hard years of COVID, they just wanted to enjoy life ‘as before’ and spend. Excess savings are diminishing and high energy prices are now making consumers more aware of prices. At the same time, inventories have been replenished as supply chain constraints have eased. Therefore, whereas companies’ costs (especially wages) are still rising, especially in the US, pricing power is eroding, which is putting heavy pressure on operating margins. Whereas revenues are still growing in the US, Q4 2022 could be the first quarter showing negative EPS growth since Q3 2020.

We downgrade Consumer staples to negative

Last year, major Consumer Staples companies were able to increase their end prices to maintain (or even increase) their profit margins, at a time when demand and costs were rising fast. Now that consumers are starting to watch their wallets, looking for cheaper brands and products, revenues of premium brands are under pressure (obviously, the opposite at discounters) whereas their costs are still high and often rising.

We consider that 2023 valuations (P/E ratios) are now too expensive for this sector (above 20 in the US), at a time when several Consumer Staples companies have issued warnings about future margins and profits. The sector could well show no EPS growth in 2023! Therefore, this month, we globally downgraded the Consumer Staples sector from Neutral to Negative/underperform.

5. Q4 2022 results & 2023 earnings expectations

In the US, Q4 2022 is likely to show negative EPS growth

In the US, Q4 2022 could be the first quarter to show a slightly negative y/y growth since Q3 2020. But more worrying is the pressure on operating margins due to the higher costs and diminishing pricing power. Therefore, 2023 earnings expectations continue to be revised downwards.  Valuations are rich in the US: the forward P/E is around 18.1x. Tech, Consumer Discretionary and Consumer Staples sectors trade at average P/E levels above 20. Industrials and Utilities are also approaching this level. Consumption resilience will be key to determining whether earnings can stabilise or if we will enter a deeper recession than priced in. For 2023, the IBES consensus is still +2.2% earnings growth, which is a bit optimistic in our view. Another worry is in Big Tech: Q4 2022 results are not impressive and earnings forecasts are still being lowered for 2023. Deep restructuring/cost cutting is needed. 

Earnings have held UP relatively better in Europe

In 2022, earnings are set to grow by +17.4% in Europe, but almost zero growth is on the cards for 2023. So far, Q4 2022 corporate earnings have been better than expected in Europe but the reporting season has barely begun (25% of European companies have reported so far).

Europe trades at a cheap forward P/E of around 12.8x. Some sectors that perform well during inflation times are still very cheap: Energy, Financials, Health Care, but also Materials taking into consideration China’s potential for recovery.

In Europe, several Semiconductors, Banks, Health Care and Luxury names have reported rather good earnings and forecasts but as mentioned earlier, it is still too early to draw conclusions. ;

6 Asian Equities view

•Overall, Asia (except India which outperformed last year) performed well in January, thanks to the peak in the dollar and China re-opening. 

•China equities continued another strong upward movement in January after the government’s U-turn in its COVID policy. We had already turned more positive on China equities at a global level in early December. Despite the strong rebound, we continue to see upside in both onshore A-shares and offshore Chinese equities (Hong Kong-listed and ADRs) due to the following reasons:

(1) Evidence of robust pent-up demand for “offline” goods, services and travel during the Chinese New Year holiday as COVID infections have peaked.

(2) Earnings estimates have bottomed out for CSI 300 (A-shares) and are starting to stabilise for MSCI China (offshore Chinese equities).

(3) Net buying from foreign investors has just returned in recent weeks after significant outflows last year, and domestic retail investors have not yet seen their significant participation in the A-shares markets.  

7 Focus on listed Real Estate

THE Sector fell sharply in 2022

Last year, the sector significantly underperformed as inflation soared and bond yields rose. Questions then arose about debt refinancing and the growth of Real Estate companies. In addition, this sector, which historically seemed relatively safe and robust, with good earnings visibility (linked to rents and their indexing), became increasingly volatile in the wake of the Coronavirus pandemic.

At the time of COVID (2020-21), office property and shopping centers had already lost value on the stock market because people were afraid to leave their homes, and were even strictly forbidden to go to some places.

In addition, some large European companies had made major acquisitions shortly before this time, thereby considerably increasing their debt. US companies are generally less affected by this concern about somewhat high debt.

In 2022, ‘Growth’ property stocks (some of which had benefited from the COVID crisis, such as logistics and data centres) suffered more as bond yields rose. 

Strong recovery in recent months

Many fears proved overdone. Admittedly, the economy is slowing, but the world is not going to enter a deep recession. Workers are back at the office and shoppers are back in the malls. Several companies in these segments also reassured the market with better-than-expected results. Listed Real Estate companies are usually well managed, their debt levels are not expected to pose major problems in the short term, bond yields seem to be stabilising, and in the end, dividend cuts have been quite moderate thus far.

But discounts are still large, especially in Europe, in the region of 30% compared with net asset values (ca. 45% discounts at the worst of the fall), while expectations of downgrades of Real Estate valuations are much more moderate today than a few months ago. The sector's recovery should therefore continue in Europe.

Favour strong, well-positioned Real Estate stocks with diversification between those benefiting from the economic recovery and more defensive stocks showing structural growth (e.g. healthcare, logistics or data centres). 

8 Sector Allocation – Consumer Staples from Neutral to Negative

Improving economic indicators encourage us to CONTINUE TO favour cyclical markets and sectors

Recent economic data have proved better than expected in Europe, thanks to energy prices going down and China’s reopening. Therefore, Cyclicals are recovering fast to the detriment of defensives (which performed relatively better in 2022). Some defensive sectors now look quite expensive at a time when pricing power and fat profit margins are being questioned. 

- This month, we downgraded the Consumer Staples sector from Neutral to Negative as valuations are too expensive in view of lower profit margins and growth.

- Inflation, albeit declining, is still too high and we recommend keeping good positions in sectors that are performing well in this type of environment (Energy, Basic resources, Financials, Health Care).

- In Materials, we note that the situation is improving for steel (prices are recovering) and cement sub-sectors (demand has been better than expected). The European economic resilience, recovery in Emerging Markets and lower energy prices are helping.  

January 2023 showed a return reversal vs. 2022: the worst sectors in 2022 have done better so far in 2023. But we are still far from the peaks reached at the end of 2021. Despite their outperformance in 2022, Energy, Basic resources, Financials, and Health Care are all still cheap. They are expected to register more gains. These sectors, as well as some REITs, perfectly fit our current Value call. 

- Banks remain another favourite sector (2022 results look good so far, thanks to rising net interest margins, solid balance sheets and the resilient economy). The sector is still cheap compared with others and versus its own historic valuation.

- Regarding European listed Real Estate, the worst seems to be behind us. This sector is now recovering whereas many REITs trade at big discounts to NAVs.

- Prudent investors may diversify via secure and rising dividends stocks (a preference here for Health Care, Insurance, some select Utilities).

- Richly-valued stocks (mainly in Defensive/ Growth/ Tech segments) remain vulnerable. Be very selective here and reduce on strength if you hold a big exposure.