J.P. Morgan has upgraded euro zone stocks to “overweight” while downgrading their U.S. counterparts to “neutral,” reversing a long-standing position.
In a note to clients Monday, Head of Global and European Equity Strategy Mislav Matejka said analysts saw a “tactical opportunity” for the euro zone to catch up, but accepted that there are “clear risks” to the call, most notably the danger of a no-deal Brexit.
Matejka highlighted that euro zone equities are under-owned at present on account of a significant spell of underperformance, having lost 20% against the U.S. over 18 months. The note uses the benchmark MSCI euro zone and U.S. indexes relative in U.S. dollar terms.
He suggested that now “could present a good entry point” with the euro zone sector neutral price-to-earnings ratio “close to outright cheap territory.”
Key to the potential for an uptick in Europe, Matejka indicated, is an acceleration of money supply and the potential for fiscal stimulus.
Money supply
Euro zone economic activity has been waning, with latest PMI (purchasing managers’ index) figures coming in at new multi-year lows last week, but Matejka noted that narrow money supply (M1) for the region has been improving, with M1 tending to precede PMIs by two to three quarters.
The broad money supply (M3) increased from 5.1% year-on-year in July to 5.7% YoY in August and that improvement was mainly driven by an acceleration in the narrow money supply.
Broad money is a measure of supply in a national economy, including highly liquid “narrow money” and less liquid forms.
“The increase from 7.8% to 8.4% YoY is particularly noteworthy as real money supply is considered to be one of the best leading indicators for the euro zone economy,” ING Senior Economist Bert Colijn said in a note Thursday.
“That said, the lag time is considerable, although this does provide a somewhat rosier view on the economy a few quarters ahead.”
Fiscal action
Matejka added that the ECB’s (European Central Bank) quantitative easing (QE) may bode well in this regard, while the possibility of an increase in fiscal stimulus speculations could aid sentiment.
“In this cycle, there were three times where euro zone net fiscal stimulus was a positive for GDP, with equities up strongly on each occasion,” Matejka said.
“Given the current activity weakness, Brexit and trade uncertainty, and the mounting political pressures on core Europe from anti-establishment (parties), we think that it might not take much for some encouraging news on this front.”
J.P. Morgan anticipates that net fiscal stimulus in 2020 might increase in a proactive way, rather than reactive as seen this year, in part because “euro zone fiscal leverage and primary surplus are far better than in the other main regions.”
With Italian 2020 budget negotiations now underway, Matejka highlighted that Italian spreads have narrowed significantly of late, suggesting euro assets should benefit.
“While we had a longstanding preference for U.S. over euro zone banks, we note that the (half-year) spread differentials are now suggesting that there could be some reversal in the underperformance of euro zone vs U.S. banks,” the note stated.
While remaining overweight technology stocks, J.P. Morgan analysts anticipate a broadening of the current rotation away from growth and into value stocks, which would further support improved performance of European equities versus their transatlantic counterparts.
While identifying this as a tactical opportunity, however, J.P. Morgan is wary of the potential impact of a no-deal Brexit, though it is not the analysts’ base case. Matejka advised against ruling out the possibility of a deal being secured before the October 31 deadline, and projected that this would “significantly help” the bank’s euro zone upgrade.
