Bank of America (BofA) is warning of the growing downside risks of European equities.
BofA researchers said the list of potential downside risks to growth has multiplied over the summer, due to worsening supply-chain disruptions, the intensifying debt crisis in China's property sector and, most recently, power shortages on the back of low supplies against the backdrop of a strong demand rebound, according to a press release obtained by Capital.com
“Our economists estimate that the hit to global consumption from the energy price shock could be as much as 1.6% this year, even before accounting for negative second-round effects, with Europe particularly exposed.
“This strengthens our belief that the macro backdrop for European equities has shifted from goldilocks (i.e. accelerating growth and falling discount rates), to anti-goldilocks, motivating a shift on European equities from neutral to negative earlier this month,” BofA said.
European energy sector
The report also noted that the European energy sector has outperformed the market by 20% since early September, helped by an 18% rise in the Brent crude oil price to a seven-year high of $84 a barrel.
“Our oil price analysis points to downside for the oil price over the coming months, given that: (a) we see scope for US dollar strength, consistent with lower commodity prices; and (b) we expect US growth momentum to remain in deceleration mode,” it said.
The BofA economists also said oil prices are among the largest overshoots observed over the past 15 years, with prices currently 30% above the fair-value levels implied by its analysis.
Global crude rebounding
The report also highlighted that global crude supply is rebounding sharply (up 6 million barrels per day over the past six months, the sharpest supply increase over the past decade), with the recent price increase set to incentivise producers further to boost supplies, while hampering demand.
“We think a rising oil price against the backdrop of US dollar strength, fading growth momentum and a rebound in oil output is likely to prove unsustainable. Our projection of lower oil prices over the coming months is consistent with renewed 15%+ underperformance for the European energy sector relative to the market,” the report said.
“We stay negative on European equities, with our base-case projections consistent with 10% downside on the Stoxx 600 to 420 by year end,” it added.
Capital goods and autos were the two sectors that outperformed strongly during the macro rebound, it said, and noted they are set up for a pull-back as growth starts to slow.
“Utilities, on the other hand, have scope to outperform, following 20%+ underperformance since last March, given that this domestic defensive sector tends to benefit in periods of fading Euro area PMIs,” the BofA Global Research report added.
The report comes as European equities were on course Friday for their best week since March – as strong corporate earnings eased economic stagflation nerves.
The pan-European Stoxx Europe 600 index rose 0.3%, heading for a weekly rise of more than 2%, while London’s FTSE 100 added 0.1%.