More watchful on stocks
We are now more cautious on global equities. Heightened economic and political uncertainty could exacerbate already poor corporate earnings trends, and valuations look elevated. We’re particularly cautious of European stocks, given factors including poor profit growth. We have downgraded European stocks to underweight, and hold a negative view of the eurozone banking sector.
Market Realist – Economic and political uncertainty weighs on stocks
Investors have become wary of global equities (EFA). That’s on a backdrop of continued uncertainty surrounding global economic growth and weak corporate earnings in Europe, Japan, and some emerging markets.
Substantial equity outflows
According to the Bank of America Merrill Lynch (BAC), investors pulled $5.4 billion out of global equities last week. The outflows from Europe were the highest at $4.2 billion, followed by Japan at $700 million and the United States at $400 million (IVV).
Conversely, emerging markets (EEM) witnessed inflows of $400 million, the fourth straight week of gains.
Pessimism prevails over European stocks
European stocks (EZU) are represented by the STOXX 600, which is trading at a forward PE (price-to-earnings) multiple of 16.1x. The stocks are vulnerable to concerns related to weak economic growth, no meaningful rebound in inflation expectations, and numerous local political issues.
The British vote to exit the European Union further aggravated the situation. The ECB (European Central Bank) estimates a 0.5% hit to the European Union’s GDP growth over the next three years.
Weak corporate earnings are also not helping build confidence. According to Lipper Alpha, second-quarter earnings of companies in the Stoxx 600 are likely to plunge 11.3% year-over-year, and revenue is expected to decline 5.5%. Excluding the energy sector, earnings may fall 8.8%.
The European banking sector, which is poorly capitalized and saddled with huge bad debts, is at a critical juncture. Negative interest rates make matter worse, affecting margins.
Against this backdrop, investors have turned cautious on European equities. According to HSBC, investors have pulled out $129 billion from European equity funds year-to-date, which is a record outflow.