The Barclays and HSBC buildings are seen amid the coronavirus disease (COVID-19) outbreak, in London, Britain, October 20, 2020.
Matthieu Childs | Reuters
With inflationary fears persisting and the business cycle maturing, Barclays envisions a period of higher volatility and lower returns for European stock markets.
However, analysts at the UK lender still find stocks more attractive than bonds and have recommended investors look to buy the downside.
Global stocks have been rocked over the past month by concerns that higher inflation may be lingering, which has pushed bond yields to multi-month highs.
The pan-European Stoxx 600 ended a seven-month winning streak in September, after global markets benefited from a favorable backdrop for a rapid economic recovery and an unprecedented supply of fiscal and monetary stimulus.
In an October strategy update released on Wednesday, European equity analysts at Barclays warned that inflation is “sticky”, the business cycle is maturing, price-to-earnings ratios are high and that earnings per share growth is expected to slow, while central banks are getting more hawkish. Price-to-earnings ratios are an important metric used by traders to assess the value of a stock.
Still, Barclays maintains a positive outlook for equities, arguing that the TINA principle (there is no alternative) still prevails as cash inflows have slowed in recent times. With price-to-earnings ratios falling, the bank expects future returns to be lower, but still positive.
âAs risk premiums rise, risk-adjusted returns will be lower. Yet we still find stocks more attractive than bonds and believe that the dips need to be bought,â said Emmanuel Cau, head of equity strategy. European.
Although growth is slowing and inflation is rising, Barclays does not foresee a âstagflationâ scenario, as demand remains strong and financial conditions relaxed.
Meanwhile, the correlation between bonds and stocks is high, but Cau argued that bonds appear more disconnected from fundamentals and therefore will be more vulnerable to inflation and political risk. The main risks in the fourth quarter include the electricity crisis in Europe as well as Covid-19, China’s economic uncertainty and the deadlock on the US debt ceiling, he said.
“Investors are still in the wild given the $ 4.5 trillion (AUM) money markets (assets under management). Stocks are the only asset class to produce positive real returns and tend to perform well in a regime higher inflation, âCau added.
“Equities are less complacent now, as investors turned to defenses in the third quarter and added downside hedges. The seasonality of the fourth quarter is generally favorable for equities versus bonds.”
Back Germany and Italy, sell British servants
Barclays holds a market weighting of European equities, which allows it to outperform highly valued US equities. good hedging against higher rates, and are not overbought.
Value stocks in this case include banking and energy, with the former being the best performing sector since the start of the year while the latter being among the cheapest sectors, with commodities also offering potential hedge. against falling stock markets if inflation persists.
They have become underweight UK domestic stocks due to supply shortages, declining government stimulus and the prospect of Bank of England rate hikes. However, stagflation concerns could cap the pound and favor UK exporters, Cau suggested.
Barclays are also overweight Germany and Italy, with economies reopening, with the European Central Bank remaining accommodating and EU subsidies now paid.
“Italy looks cheap and has stronger EPS dynamics than Spain. We are positive on banks, which have a much larger market cap weight in the periphery than in the core,” Cau said.
âGermany has grossly underestimated its relative BPA momentum and looks cheap. China is a headwind but a lot is in the price. Election results without a clear majority mean coalition talks could drag on for too long. months, but a centrist government should preserve the status quo. “