So how have we updated our asset views in response? We have downgraded European stocks to underweight, and hold a negative view of the eurozone banking sector. We have a preference for income and have upgraded U.S. credit and EM debt to overweight. We like U.S. investment-grade credit, hard-currency EM debt, stocks in selected EMs and global quality and dividend growth stocks. The bottom line: Overall, in today’s uncertain, low-growth environment, we prefer credit to equity and believe exposure to gold and alternatives as diversifiers makes sense.
Market Realist – European stocks likely to underperform
As concerns about weak economic growth are further aggravated in the aftermath of Brexit, European (EZU) stocks are likely to see downward trends for the rest of the year. The prolonged uncertainty and loss of confidence could lead to investment delays, lower consumption, and weak job growth, affecting companies’ top line and leading to higher financing costs, which could weigh heavily on stocks. Already, the Stoxx Europe 600 is down 7.9% year-to-date.
As a result of the Brexit vote, European stocks (IEV) witnessed sharp fund outflows. According to data from HSBC Global Research, around 2.5% of total assets under management were pulled out of European stocks after the Brexit results. EPFR Global data show that $15.3 billion has been redeemed from European stocks since the referendum. This was the 22nd consecutive week of outflows, the longest stretch since 2008. Year-to-date, European stocks have witnessed outflows worth $54 billion.
Eurozone banking is a weak spot
The banking sector in Europe (IEUR) is a weak spot with mounting bad debt and huge amounts required to recapitalize many feeble banks. Italy (EWI), which is at the center of the European banking crisis, is riddled with bad debt to the tune of 360 billion euros, or 20% of the country’s GDP. Banca Monte dei Paschi di Siena, Italy’s third biggest bank by assets, is on the verge of collapse and has already lost 99% of its value since 2008. The worry is that the collapse in Italian banks might put other European banks at risk.
What to look for
In view of such uncertainty in the wake of the Brexit results, emerging market debt looks good because of rising credit quality and higher yields relative to developed countries’ corporate and Treasury bonds. US investment-grade bonds also seem to be a better bet due to lower risks. The dividend (DVY) growth stocks look attractive at 13.4x forward earnings with a potential of a consistently growing dividend. The dividend growth stocks also tend to be more resilient in volatile markets.