Europe
Strategy Matters: How EM risks are priced in European equities
We look at the EM-exposed areas of the European market to assess how the slowdown and risks to emerging markets have been priced. We find that our EM-exposure basket (GSSTBRIC) has de-rated and is back to an average rating versus the market – but is still not at a discount. Some slowdown in growth is clearly priced for EM exposed areas, but in our view there is still further to go, with Basic Resources, Industrial Goods & Services and Chemicals most vulnerable on the industrial side, and Food & Beverages still vulnerable on the consumer side.
What are European equities pricing in for EM growth?
Our basket of EM-exposed stocks (GSSTBRIC) has underperformed sharply – down 14% versus the market over the past year. This recent weakness stands in contrast to the substantial outperformance and re-rating in the 2007-10 period. We find that the de-rating of our basket already implies some slowdown to EM growth; but the risks are still to the downside, and the stocks are not yet offering value, in our view.
EM-exposed industrials & EM-consumer stocks both vulnerable
Splitting our EM basket into Industrial (GSSTBRCI) and Consumer exposure (GSSTBRCC), both appear vulnerable. The industrial names were the ones to benefit from the booms in fixed asset investment and commodity-related demand from the early 2000s. Their underperformance recently has been small compared with the performance in the previous decade and they remain very sensitive to EM growth. The consumer names should ultimately benefit as China’s growth becomes more consumption-driven. But near term, we find they are negatively correlated to EM rates, which our economists expect to increase further over the coming year.
Remain Underweight most sectors with high EM exposure
We also look at the European sectors most sensitive to EM. We find that while Food & Beverages has de-rated versus the market – it was on a 60% P/E premium that has now fallen to c.30% – it is still expensive versus history. We stay Underweight. We find more value in Personal & Household goods, but even here relative multiples have returned to average rather than being clearly cheap; stay Neutral. The performance and relative valuation of Industrial Goods & Services and Chemicals are both linked to EM growth and we continue to see these as vulnerable; remain Underweight. Basic Resources does not look expensive and the 4Q earnings season was relatively good, but the sector remains exposed to downward moves in metals prices; we remain Underweight.