Welcome to Planet QE — Yield/Spread Squasher
* Welcome to Planet QE — Our QE conclusions remain the same: 1) drive further euro weakness, towards parity vs USD in 1H16, 2) provide an effective nominalGDP growth put, with Citi economists forecasting rise from 1.2% nominal GDP
growth for Euro Area this year to 3.5% in 2016E, 3) support higher asset prices.
* Stay bullish European equities — ECB QE is key ingredient in our bull case for European equities. We retain our long-held end-2015 Stoxx target of 400; c30% above last October’s lows vs c10% higher than current levels. We note that our
credit strategy colleague, Hans Lorenzen, expects € spreads to tighten 20-25%.
* Double-up, not double-down — We continue to think that there is a greater likelihood of “double-up”, ie positive earnings growth & re-rating, than “doubledown”, ie no/negative earnings growth & de-rating. The strong relative case for
equities vs bonds suggests marginal buyers will be more interested in buying equity.
* What's squashed, what's not — Policy actions, including words, have already had a big impact on some spreads, eg peripheral-core government bond spreads. Our rate strategy colleagues see further spread gains for most peripheral bonds but the big move is already done. We find more interesting spreads involving equity.
* Equity spreads — There are two types of spread at an equity level: 1) equity vs fixed income, 2) intra-equity market spreads. The former shows equity at historic relative valuation lows against many fixed income assets. This supports our bullish stance on equities providing there is no macro/EPS/systemic shock.
* Intra-equity spreads — European country/sector valuation spreads, on a price/book basis, only wider in last 20-30 years in late 1990s = suggests investors should take on more value. This means buying Financials and Commodities, which makes many uncomfortable. We prefer former to latter, but highlight rotation risk.
* Style spread — Using our Quant team’s style analysis, we show big spread, between Low/High Risk. Spread only wider in 2008-09 & early-2013; then, it paid investors to take on more risk. Be more selective, for now. Saint Gobain, Aegon,
KBC, DSM in this group and have 3%+ DY, 5%+ 2-year dividend CAGR.
* Style non-spread — Again, using our Quant team’s style analysis, we show the non-spread between High/Low Value, ie expensive/cheap, on a P/E basis. This continues to imply that investors should run earnings momentum strategies. We add other factors to positive relative earnings momentum: balance sheet, surplus FCF, positive EUR/USD beta = HSBC, Valeo, Unicredit, Peugeot, Persimmon, ARM, Wolseley, Novozymes.