Global reflation and good EU economic momentum. We continue to believe in a base case of global reflation – that is, moderate increases in growth, inflation and rates. Macro newsflow remains strong and our economists have recently lifted their Euro Area GDP growth forecast to 1.8% for 2017.
Strong EPS growth in Europe in 2017. European earnings look set to rebound significantly in 2017 as margins and top line growth improve. We recently increased our top-down 2017 EPS growth forecast from 12% to 16%. This is the first year since 2017 when EPS estimates are being upgraded.
8% upside to our base case price target. Our base case rolling 12m price target offers 8% upside from here and assumes little change in Europe’s N12M PE on a 12m view. Investor sentiment metrics have moderated significantly in recent weeks and set the scene for a near-term rebound if political uncertainties start to fade. Our MTI and CVI indicators are still in sell territory, but only just.
Value stocks still look depressed. Value stocks have underperformed YTD as the global reflation trade stalls. Provided our base case view on global reflation is correct we’d still look for Value to outperform over the medium-term and continue to expect a revival in the efficacy of the PBV factor.
OW Financials. We believe Financials are likely to be the biggest beneficiary of the reflationary theme, driving both an upturn in earnings and a valuation re-rating as interest rates/yields rise. We are overweight Banks and Insurance.
OW Energy/Steel. Within the commodity space we prefer Energy to Miners at this point given the latter’s stronger performance and higher valuation and our bullish view on oil prices. Oil stocks (majors and service names) should see a strong rebound in EPS (margins are rebounding) and FCF, with the latter suggesting a valuation re-rating over time. We also like Steel stocks that should benefit from ongoing policy changes in the US.
UW Cyclicals. We believe cyclicals are pricing in the largest amount of good news with relative valuations close to 40-year highs and consensus positioning likely elevated. The sector has arguably already priced in the improvement in economic data and earnings upgrades and would be vulnerable to any peaking out in economic lead indicators. We are underweight Consumer Discretionary and Industrials.
UW Defensives. We are underweight Defensives as earnings momentum remains poor (relative revisions are at a 5Y low) and (high) valuations are under pressure from increasing bond yields. Predominantly due to lower valuations, we prefer Pharmaceuticals to Consumer Staples and Telecoms to Utilities.
UK mid-caps look interesting. We are UW the UK given our FX team’s bullish view on GBP. The latter recommendation suggests ‘weaker GBP beneficiaries’ should underperform going forward and that UK mid-caps look increasingly attractive post poor performance and given low relative valuations.
Prefer Europe to US. After many years of earnings and price underperformance, the relative case for Europe looks more favourable for this year given a combination of stronger EPS growth, attractive relative valuations and a reflationary macro backdrop.
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