Given the heightened risk of lower corporate earnings in Europe as well as the prospect of higher interest rates and recession, we have “doubled” our previously modest underweight in European equities, while maintaining a cautious view of investment risk taking. .
Reasons to be afraid
We believe there is greater potential for earnings disappointment in Europe than in the rest of the world, which is not yet reflected in equity valuations. Another factor clouding the outlook is that bank rates are expected to rise quite sharply in Europe. The policy of the European Central Bank has shifted towards fighting inflation, despite the already pronounced downside risks to economic growth.
A third reason for this larger underweight is the impact of the conflict in Ukraine, which we consider particularly intense for European companies close to the cycle and geographically close.
Finally, analyst forecasts call for barely positive growth in the second quarter of 2022. This leaves Europe arguably closer to recession, certainly relative to the US. The impact on corporate earnings would be greater given the high operating leverage of European companies.
Risks to future consumption – and growth
In the United States, consumption has generally held up well so far. However, the 30-50% increases in inventory at U.S. flagship retailers such as Walmart and Target suggest demand has moved ahead of what they had hoped for. Persistent and high inflation is an obvious risk to future consumption, further complicating the ability of central banks to tighten policy without slowing growth too much.
In other words, a soft landing seems more tenuous the longer current conditions last. This has resulted in the notable flattening of yield curves in Europe and the fall in US breakevens in recent weeks. Liquidity conditions in fixed income, particularly European credit, have been challenging, although in European investment grade bonds the widening of spreads has been indiscriminate.
Asset class views as of June 7, 2022
Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different views and make different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income from them can go down as well as up and investors may not get back their initial investment. Past performance does not guarantee future returns. Investing in emerging markets, or in specialized or restricted sectors is likely to be subject to above average volatility due to a high degree of concentration, greater uncertainty as less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of developed international markets. For this reason, portfolio transaction, liquidation and custody services on behalf of funds investing in emerging markets may involve greater risk.