How the stock markets will go
Because the stock will still be under pressure. The analysis by Michele Morganti, Senior Equity Strategist of Generali Investments
Equities will remain under pressure, at least in the coming months. The war will not end soon and the sanctions, as well as the problems of energy supply, are driving inflation that still surprises analysts, especially in the Eurozone. This alarms central banks, which will not stop soon: the aggressive stance and rate hikes by central banks continue to lead to a deterioration in financial conditions for longer, raising the cost of capital for firms and luring investors to ask for a high, if not higher, risk premium for the shares. The volatility of bonds also remains extremely high, another headwind for the appetite for equities. In this context, the EPs continue to be under pressure.
As a result, we lowered our PE target (now 16X in the US and 12.5X in Europe) due to higher yields and inflation. Historically, with inflation between 2.5% and 5%, the risk premium required by the market results in a level of the S&P 500 index above the current level in 12 months: 4,129 or more. But for higher inflation levels, such as 5% -6% or 6% -7%, which we will likely experience in the coming months, the required risk premium historically increases resulting in much lower target price levels. Furthermore, such higher inflation ranges also produce a dangerously higher standard deviation of the equity risk premium.
Finally, while central banks remain rather aggressive, the risk of a major economic slowdown increases and markets have yet to afford a hard landing. So far, the first quarter reporting season and macro surprises have held up well in the Eurozone, but we see cause for concern due to deteriorating real income and global activity, as well as prolonged war uncertainty. As a result, we expect lower-than-consensus earnings growth in 2022-2024. Another source of risk is represented by the US Tech segment, whose valuation bubble has not yet dissolved.
In conclusion, in the short term we strengthen our underweight position on equities despite the potential positive total return in 6-12 months (approx. 3%; with a PE of 12.5X and EPS growth below consensus), the high company cash flows and good inflation hedging profiles of real assets, and low positioning. Positioning is indeed quite small, but relative equity versus bond flows still persist near a cyclical high. In the worst case scenario, the European and US markets could still have a drop of 14% (3,170 for the S&P 500). The ceasefire, therefore less aggressive central banks and an economic cyclical minimum would represent factors capable of triggering a new phase of purchase.
We are slightly overweight in UK and US equities relative to the European market. As for sectors in Europe, we look for low valuations, positive correlations with a peak in the dollar and protection from high volatility and inflation. We slightly reduced slightly expensive defensive exposures such as the pharmaceutical and food sectors, we also reduced our exposure to the Telecom sector, a more expensive Value segment and with possible negative earnings revisions, while we increased our exposure to Tech Hardware, diversified financials, durables and utilities.
The Growth segment is also at risk – due to higher rates – but it seems to have already been largely sold. Towards energy and materials we are still Overweight, although they are starting to show higher valuations, as well as towards oil, financials, durable goods and utilities.
We believe the recent EM rally is potentially at risk as we see slight overvaluation, declining export orders and still weak earnings that could put EM equities under pressure in the near term. Over the longer term, the dollar's spike and emerging market credit yield advantage should be supportive.
Chinese equities are undervalued on a number of indicators and should benefit from improving credit momentum, robust political support, easing of lockdowns and technological regulation. Furthermore, Chinese inflation remains subdued relative to that of developed markets. Any renewed lockdowns, on the other hand, would represent a risk. Within the emerging markets, we also look at Korea, which should benefit from the improvement in Chinese economic activity.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/come-andranno-i-mercati-azionari/ on Mon, 11 Jul 2022 06:13:47 +0000.