International | Apr 10 2017
Saxo Bank, in its quarterly outlook, observes the gap between perception and reality is wide among market players and this sets up opportunities for attractive trades.
-European economy expected to outperform the US over the next four years
-Reflation trade expected to end by mid year with correction in global equities
-Energy sector seen vulnerable while defence to outperform
By Eva Brocklehurst
Saxo Bank, in its quarterly outlook, reflects on an old investor truth that profit is best found in mispriced assets as well as illiquidity, and believes this is precisely the situation that exists in Europe at present. The gap between perception and reality is wide, which sets up attractive trades such as long euro and cyclical stocks.
The analysts observe that European assets, with the exception of German fixed income, carry a discount based on nervousness about the French and German elections and the end result of the exit of the UK from the European Union. While some of the concerns are valid, Saxo Bank believes others are valid but over-priced.
The analysts envisage the European economy will outperform the US over the next four years. Europe's GDP growth has surged almost 3% and, with investors focusing on the political landscape, they suggest this fact has been overlooked.
The drivers are improving financial conditions, upward pressure on prices and increasing business confidence. This improved picture is at odds with the valuation discount to US equities and one of the main reason behind Saxo Bank's overweight Europe and underweight US theme.
France And Euro
The analysts believe there is little to no chance of France leaving the euro although the market is maintaining a wait-and-see attitude. Even if Marine Le Pen wins the presidential election, any constitutional change needs to be proposed by the government and as president she would need a majority in the June legislative elections to call a referendum.
The analysts believe foreign investors are wrong to focus on the presidential election. The main risk is a new influx of immigrants and if this occurs prior to either the French or German elections it could become a major factor, the analysts acknowledge. Once the elections are over in the September quarter a significant move in the euro's value is expected.
European Equities
While the market appears to be factoring less than a 10% chance of recession, Saxo Bank envisages more than a 60% chance. While not predicting a recession, economic modelling indicates a significant slowdown as a large credit impulse from China and Europe has not reversed, which should make the market conservative and risk averse.
In the slowdown, Europe is expected to do better than the US, the euro do better than the US dollar and Asia will be under pressure to reform away from debt as the main driver of growth. The analysts suggest no one seems to believe the momentum search in equities that is based on low yields or the deductibility of interest on debt for corporates will end any time soon.
Saxo Bank believes the reflation trade that started on the back of US President Donald Trump's victory will face obstacles. Global equities are up 6.5% in US dollar terms and the outperformers are Hong Kong, emerging markets and Brazil. The analysts believe the reflation trade will end by mid year with a healthy correction in global equities. Marginal positive economic growth is all that is expected, as Donald Trump seems to lack backing from his party for a lot of his policies.
The analysts believe investors should be overweight in low volatility and high-quality stocks while selling strong momentum and value stocks. Saxo Bank's main bet in the current quarter is that European equities will outperform US and Japanese equities.
Technology stocks are expected to do well simply because this remains the only sure way of obtaining a growth component in the equity portfolio. The fading reflation trade is expected to lead to underperformance in financials but a stronger performance among consumer stocks.
Energy And Defence Sectors
Saxo Bank continues to believe the energy sector is vulnerable. Outstanding debt to asset values is at the highest level since 1995, fuelled by cheap credit. Unless the oil price goes higher, the analysts suspect a refinancing crisis could commence. Saxo Bank retains a view that the global energy sector has an unsustainable capital structure, given the oil price outlook, and debt restructuring is the only way to restore balance.
On the other hand, defence companies are expected to outperform. Defence spending in the Western world is historically low, but the Trump administration is forcing other NATO members to step up and commit to the 2% of GDP on military spending agreed in the treaty.
Commodity Dollars
The analysts observe risks for the Australian dollar stem from the housing market finally rolling over, as Australian banks tighten credit standards and China's momentum continues to slow. The New Zealand dollar is observed to be unwinding its overvaluation while the Canadian dollar, on a relative basis, appears under priced. Themes which could emerge based on the Saxo Bank expectations for the quarter are downside to the AUD/CAD and upside to the EUR/NZD.
The analyst harbour a concern that a withdrawal of Chinese liquidity could weigh on the outlook for emerging market currencies in the second and third quarters and temper enthusiasm for the reflation trade.
The analysts believe that there has been a sharp reality check after a wave of enthusiasm for commodities was spurred on by the Trump reflation trade expectations. The euphoria generated, along with the OPEC agreement to cut production, a dramatic increase in speculative demand which lasted well into February. Yet, there was a lack of price momentum to justify this bullish build up in speculative trades.
The analysts note renewed weakness, especially in crude oil during March, finally triggered a record amount of selling from funds. The second quarter is not expected to be a turning point as multiple risks persist.
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