We modestly reduce the size of our overweight in Continental European equities and reduce our year-end target for the Euro Stoxx 50 to 3,350 from 3,400. We increase our overweight of Germany, raise Spain to overweight and increase the underweight of France. We would still stress the domestic demand story. We slightly add to US equities using the proceeds from our Continental Europe downgrade and increase our S&P 500 year-end target to 2,150 from 2,050. Our most preferred region is now GEM.
* What has gone wrong and seems unlikely to improve: Euro strength (each 10% rise in the euro trade weighted takes c.8 percentage points off EPS growth), and we see the EURUSD rising to 1.15-1.20; European equities are a consensus long but we have seen only partial capitulation (17% of inflows since Dec 2014 have flowed out); internet disruptors account for 0.2% of market cap (compared with 6.3% in the US); the political risk is likely to rise (immigration, anti-euro parties' popularity).
* What has gone wrong, but is likely to improve: Continental Europe is leveraged to the global cycle, which is now showing signs of turning higher; GEM exposure in Europe is higher than that for Japan or US (and Chinese news flow improving) and this should help European equities; Europe has nearly double the market cap weighting in banks relative to the US, but banks appear a tactical buy. The sector adjusted P/E has fallen to be 6% below the US versus a 2% premium in January; once we adjust for the normalisation of the cycle, we think it should be on an c.11% premium.
* What remains supportive of an overweight: The equity risk premium is 8.3% (versus warranted of 8.0%) with German pension fund equity weightings of just 15%; relative performance correlates to growth differentials and implies that Continental Europe is discounting less than 0.5% GDP growth (compared with our view of 1.5%); we forecast EPS growth of c.3% this year (in line with consensus) and c.10% in 2017E (versus consensus of c.12%) on the back of a rise in asset turns, lower interest charge, and modest margin improvement.
We increase our overweight of Germany, raise Spain to overweight and increase the underweight of France. We would still stress the domestic demand story (Geberit, Thomas Cook, Cap Gemini, Sap, Assa Abloy, Accenture and Lear are cheap on Credit Suisse HOLT® and Outperform-rated).
* We slightly add to US equities using the proceeds from our Continental Europe downgrade and increase our S&P 500 year-end target to 2,150 from 2,050. The US now scores top on both our earnings and economic momentum scorecards, but valuation (with P/E relative at an all-time high), a pick-up in global IP (which is bad for the US as it is a defensive market) and rising rates (causing the US to underperform 75% of the time) leave us underweight. Our most preferred region is now GEM following the increase of our overweight on April 2 (Add to GEM, downgrade Japan) and our upgrade on December 2.