Generali Investments: Equities, remain cautious short term
14 JUL, 2023
By Michele Morganti, senior equity strategist at Generali Investments
We are still cautious about equities short term due to sticky core inflation, tightening credit conditions and macro indicators pointing south (especially in the euro area, EA). Negative signals come also from the inverted yield curve and plunged money aggregates (M1 and M2, in the US and the EA). Furthermore, positioning is not low any longer but rather neutral. Finally, PEs look exuberant vs. real rate levels, credit spreads and GDP growth (especially for the US).
Corporate earnings: still downside potential for earnings and margins
We see a slight slowdown in earnings growth in 2023: the bottom should be -3% yoy for both US and EA in Q3-Q4. We see a better momentum thereafter, still remaining below consensus in 2024 and 2025 (by -5% and -9%, respectively). The main reason on which we base our expectation of some decrease in pricing power, margins and ultimately profits is the fading of the main exceptional circumstances which led to their increase. Monetary policy’s disinflationary power acts with a lag of some quarters. In this respect, in H2 2023, till most probably Q1 2024, the economy should still feel the hit.
In particular, we see post-pandemic strong demand to stabilize, global growth going through a soft patch, household saving to normalize as well as much lower mismatches in demand and supply. The stronger trade-weighted euro will not help the EA, too, though its negative effects may be alleviated by declining energy prices. Finally, the ECB’s Corporate Telephone Survey (CTS, Q2 2023) reports large non-financial (NF) companies expect margins’ deterioration and a weakening demand outlook. The mentioning of the latter has also increased as a keyword in the EA Q1 earnings calls.
12-month view: positive TR returns (3%-7%), favouring ex-US indices
We OW Defensives and Growth vs Cyclicals, slightly US vs. EMU, Japan, Switzerland, China and India. Negatives for cyclical sectors are no support from our quant models based on ML, relative earnings strength and falling industrial confidence. Headwinds are also represented by weaker global Sentix economic expectations and EA macro surprises plus our expectations of decreasing yields. Sector OWs: Durables, HC Equipment, Food and Food retail, Software, Materials; UWs: Capital goods, Insurance, Media, Telecoms, Transportation.
We upgrade banks to neutral: credit spreads remain under pressure but with limited negative risks from here. On the other side, extremely low valuation should offer some support vs. deteriorating fundamentals. We refer to capped 10-year yields, lower growth, higher defaults and cost-push inflation. We increase Materials and Durables to a slight OW: benefits from possible China support package, improving relative valuations. We increase the UW on Telecoms. We OW Japan due to high expected earnings growth for 2023 and 2024, shareholder-friendly restructuring (cash to stockholders, higher ROE etc.), high country score (appealing composite valuation rank) and attractive excess CAPE (cyclically-adjusted PE) yield vs. real rates. We OW China mostly based on very attractive valuations and expectations of more policy support ahead: China is considering a broad package of stimulus measures to boost its economy. In Switzerland (OW SMI index), earnings and GDP growth remain sustained with also attractive PEG (PE/earnings growth) when adjusted further for the level of ROE and cost of equity.
Finally, we maintain an OW on India which shows an increasing GDP growth (albeit at a slow pace), inflation peak passed, good Q1 reporting season, improving FDIs, and a better adj. PEG when compared to the EA.
On a 12-month horizon we see positive mid-single digit total returns, favouring ex-US indices. Both continuing decline in inflation and bond volatility (MOVE index) plus increasingly appealing equity earnings yield gap vs. 10-year real rates look supportive for equities. We add to this the usual good behaviour of risky assets once investors are finally convinced that peak rates are reached, plus our constructive historical analysis of S&P 500 fair value based on the lower risk premium requested by investors as we move in time to lower inflation ranges (2.5%-3.5% versus 3.5%-5%).
Upside risks: Positioning not exuberant, declining MOVE and low VIX, plus Chinese supportive policy. Downside risks: credit event (though CBs would step in), pronounced slowdown, higher rates with lingering hawkish CBs.
