Barclays and HSBC buildings are seen during the coronavirus disease (COVID-19) outbreak in London, United Kingdom on October 20, 2020.
Matthew Childs | Reuters
With ongoing inflation fears and the maturity of the economic cycle, Barclays sees a period of higher volatility and lower returns for European equity markets.
However, analysts at the UK lender still find stocks more attractive than bonds and have recommended investors buy the dip.
Global stocks were rocked last month by concerns about continued higher inflation, propelling bond yields to multi-month highs.
The pan-European Stoxx 600 saw a seven month streak of victories in September after global markets enjoyed a favorable environment of rapid economic recovery and an unprecedented range of fiscal and monetary stimulus.
In an October strategy update released Wednesday, Barclays’ European equity analysts warned that inflation was “sticky”, the economic cycle is maturing, P / E ratios are high and earnings per share growth will slow as earnings are growing Central banks are becoming more hawkish. Price / earnings ratio is an important metric used by traders to measure the value of a stock.
However, Barclays maintains its positive outlook for stocks, arguing that the TINA principle (there is no alternative) prevails as fund inflows have slowed recently. Given the lower price / earnings ratio, the bank expects lower, but still positive, returns going forward.
“If the risk premiums rise, the risk-adjusted returns will be lower. However, we still find stocks more attractive than bonds and believe that dips should be bought, ”said Emmanuel Cau, Head of European Equity Strategy.
Although growth is slowing and inflation is rising, Barclays does not expect a stagflation scenario as demand remains strong and financial conditions are loose.
The correlation between bonds and stocks is now high, but Cau argued that bonds are more decoupled from fundamentals and therefore more vulnerable to inflation and monetary policy risk. Major risks in the fourth quarter include the power crisis in Europe along with Covid-19, China’s economic uncertainty and the stalemate on the US debt ceiling, he said.
“With money markets (assets under management) of $ 4.5 trillion, investors are still left with dry powder. Stocks are the only asset class that generates positive real returns and tends to do well in a system of higher inflation, ”added Cau.
“Stocks are less complacent now as investors returned to the defensive in the third quarter, adding downside hedging. Seasonality in the fourth quarter tends to support stocks versus bonds.”
Back in Germany and Italy, sell British domestic workers
Barclays has a market weighting on European stocks, which suggests they outperform the highly-rated US, have good protection against higher interest rates and are not overbought.
Value stocks in this case include banks and energy, with the former being the best-performing sector since the start of the year, while the latter is among the cheapest sectors, with commodities also providing potential hedge against falling equity markets if inflation persists.
UK domestic stocks were underweighted due to supply shortages, weakening government incentives and the prospect of interest rate hikes by the Bank of England. However, stagflation concerns could cap the pound and favor UK exporters, Cau suggested.
Barclays is also overweight Germany and Italy as the economies reopen, the European Central Bank remains accommodating and EU grants are now being paid out.
“Italy looks cheap and has stronger EPS momentum than Spain. We are positive about banks that have a much greater weight in market capitalization in the periphery than in the heartland,” said Cau.
“Germany has clearly fallen short of its relative EPS momentum and looks cheap. China is a headwind, but a lot is included in the price. Election results without a clear majority mean that coalition talks could drag on for months, but a centrist government should maintain the status. quo. “