The Only Way Is Equity — European equities have delivered c145% returns since early-2009. More recently, European equities have been sharply re-rated, from c10x in late-2011 to c16-17x now, on a trailing P/E. This is not the start of the equity cycle. But, we stay bullish due to:
1) inflecting European GDP and better macro ahead,
2) inflecting European earnings,
3) super-cheap relative valuations, &
4) the prospect of strengthening demand for equity, i.e. de-equitisation, inflows.
Overall, we target c20% returns to end-2014. Within the market, we think investors will be
rewarded by focusing on earnings leadership, restructuring and income. We maintain our barbell of risk (REV) and quality (surplus FCF with strong balance sheets), but continue to skew further to risk. We prefer Financials to Cyclicals to Defensives. Watch tapering, politics and EM for risks.
Focus List Europe : AB Inbev, Adidas, Aviva, Axa, Barclays, BG Group, BNP Paribas, Continental, Danske Bank, Essilor, ING Groep, Kering, Linde, Novartis, Renault, Rio Tinto, Shire, Siemens
European MArket Outlook :
Macro better in 2014 — The macro environment continues to get better in two
ways: 1) reducing risks, 2) increasing opportunity. Falling macro risks are driving a
synchronised pick-up in risk appetite from capital allocators, investors, etc. Citi
economists expect global GDP growth to rise from 2.4% this year to 3.1% in 2014E.
* Profits better in 2014 — 83 straight weeks of net earnings downgrades. Better
macro, eg 20% rise in nominal GDP growth, 2014E vs 2013E, should = better
profits & less downgrades. We see c10% European earnings growth in 2014E.
Financials’ earnings inflected in 2013. Commodity earnings to inflect in 2014E.
* Valuation mixed in 2014 — Two years ago, equities = cheap in absolute & relative
terms. Now = mixed message. European equities trade 20% above post-1972
average trailing P/E, but at post-1990 average. European equities = cheap on
CAPE (15x vs 20x long-term avg.) and super-cheap relative to other asset classes.
* TOWIE in 2014 — TOWIE = The Only Way Is Equities. Equities are arguably more
attractive than at any time in the last 40 years to non-equity investors based on: 1)
positioning, 2) relative valuation, 3) extending risk-adjusted track record, 4) deequitisation
spread. This is likely to drive continuing inflows to equities in 2014.
* Market targets in 2014 — Despite re-rating, better macro, better profits, supercheap
relative valuation and inflows keep us bullish. Our end-2014 targets of 8000
for the FTSE 100 index and 370 for the Stoxx index are based on cumulative 2013-
15E earnings growth of 20-25% and an end-14 12-month forward P/E of 13.5-14.5x.
* Key risks in 2014 — Shares = more expensive, but that is not enough to turn
bearish. To be properly bearish, investors need: 1) rapid normalisation of interest
rates, eg 1994, 2) end of credit cycle, eg 2007, or 3) global recession, eg 2008.
These outcomes = unlikely, but keep close eye on tapering, politics & EM risks.
* Key themes in 2014 — 1) regime change & the 7Rs, 2) from value compression to
earnings leadership, 3) where to find re-leveraging optionality, hence earnings
leadership, 4) barbelling risk (eg REV) & quality (eg surplus), 5) income, 6)
price/market share winners, ie world champions, & 7) what next for mega-cap.
* Sector strategy in 2014 — We Overweight Financials (Banks, Insurance, Financial
Services) & Cyclicals (Travel & Leisure, Autos, Technology), which should be
exposed to better macro, deliver better profits in 2014 and also score well on our
barbell of REV & surplus FCF. We Underweight Food & Beverage, Utilities,
Chemicals, Oil & Gas.
* Focus List for 2014 — The Citi Focus List Europe combines Citi analysts’
conviction Buys in liquid stocks with our key strategy themes. The current list is:
ABInbev, adidas, Aviva, AXA, Barclays, BG, BNP, Continental (new), Danske Bank
(new), Essilor, ING, Linde, Kering, Novartis, Renault, Rio Tinto, Shire and Siemens.