We increase the size of our overweight in Continental European equities: 5 of the tactical factors that led us to reduce the size of our overweight in May have improved. Europe's sector adjusted P/E is now the same as the US (versus the 8% premium in early May); PMI new orders are heading up, after their April pause (and consistent with 2% GDP growth versus 1.5% consensus); Bunds are now oversold, having been overbought (the sell-off in Bunds has supported the euro); May and June are typically the worst months of the year for European equity performance; and we were worried about an overbought
market ahead of Greek debt repayment deadlines this month.
We stick to our Eurostoxx 50 target of 4,000 for year-end and take Europe to 19% overweight (from 17%)
highlighting: i) European equities are pricing in a 20% chance of a Grexit (we think there is a 5-10% chance of Grexit, with a
15-20% probability of capital controls). Greek bonds are pricing in a 40-50% chance of default. On 4 measures of normalised earnings, Europe is trading 8% below its typical valuation discount to the US and 36% cheap in absolute terms against the US; ii) European markets seem to be discounting c0.5% GDP growth (yet there are lots of reasons why we believe growth will be 1.5% to 2%); iii) Europe outperforms when global PMI new orders rise (as we think they will); and iv) the differential pricing power of labour: wage growth is falling in Europe but rising in Japan, the US and the UK (this is key to monetary policy, margins and length of cycle).
Greece: We continue to see a very high probability of a temporary deal. Deposit outflows have now reached levels where weaker Greek banks are running out of collateral, and hence Syriza will likely have to compromise. We think even if there were a Grexit, there is only a one in three chance of a systemic crisis. Under such a scenario, France would be more vulnerable than investors realise (not least because French equities are trading on a near record P/E relative).
Stock screens: We highlight Outperform-rated stocks that have underperformed since the market peak and look abnormally cheap on Credit Suisse HOLT® with positive earnings revisions: Assa Abloy, Akzo Nobel and DT; and European companies which simply look cheap (on P/E, P/E rel, HOLT): Valeo, Swatch, AXA, Atos, Rieter and Total.