The Factory Daily Letter
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The consensus sees some value in European equities in an extremely uncertain macroeconomic environment
In March 2022, we published a review of analysts’ expectations for Eurozone GDP, inflation and equity markets and gave a hypothetical year-end target based on a technical analysis scenario. While it was by then already apparent that a period of uncertainty was looming – amid slowing economic growth, rising inflationary pressures and the gradual removal of support (and tightening) from the Fed and the ECB – the Ukrainian crisis put a pin in any bullish expectations and further exacerbated market volatility, growth concerns mounting on rising commodity prices and inflation expectations.
So following our letter on the changing consensus in the US (that we published Wedensday), today we look again at the key economic and financial metrics that have been re-visited by analysts and present again our updated technical outlook on the Euro Stoxx 50.
Growth expectations have continued to be lowered
As the blue line in the chart below illustrates, Eurozone GDP forecasts for 2022 rose through 2021 (even if they remained stable at around 4% for the latter part of the year). But since the beginning of this year (and Russia's invasion of Ukraine in particular) they have fallen sharply (from 4% before the invasion to 3.3% in March - and around 2.7% as we write), reflecting the significant risk to eurozone economic activity that continues to be posed by the ongoing war. The forecast for 2023 (in orange in the chart below) remains much weaker, at about 2.3% (yet has not suffered significant downward revisions so far):
The consensus on inflation continues to rise
While inflation expectations have been above their long-term averages since the beginning of 2021, rising energy and food prices have nonetheless forced economists to revise their 2022 inflation targets even higher, war in Ukraine pushing the average inflation expectation figure for the eurozone this year up to 6.7% (from 3.8% before the war). Such is far above the average rate over the last 10 years (and the ECB’s 2%’s target rate). Any normalisation is not currently expected before 2023 (currently forecast at 2.7%):
The latest Flash PMI surveys for May showed decent near-term momentum and some signs that inflation could be peaking
While economic momentum has been suffering since the end of last year and the outlook is looking bleaker in light of Europe's dependence on gas supplies from Russia, the latest PMI figures nonetheless showe some positive signs. Despite the headline figure that came in below consensus expectations (54.9 vs. 55.1 expected), the sector breakdown showed that services activity remained robust in May mainly due to growth in the recreation & hospitality sector which continues to benefit from post-Covid reopening. Meanwhile, manufacturing output (+0.5 points to 51.2) growth improved slightly in May, but supply shortages linked to the war in Ukraine and China's lockdowns have continued to drag on manufacturing activity. Of note, new orders (-3.4 points to 48.2) fell for the first time since June 2020. Digging deeper into the data, while price pressures remain, manufacturing input and output costs have fallen since April and supply constraints are anecdotally less prevalent. Labor market conditions were once again a bright spot. Strong hiring was reported in both manufacturing and services, with the increase in services employment being the strongest in nearly 15 years.
Thus the May PMI (flash) survey data so far suggest that growth remains resilient in the eurozone thanks to the strong momentum in the services sector. It remains to be seen how long this can be sustained, especially given the squeeze on household purchasing power. Average PMIs for Q2 so far (April and May) are consistent with a Q2 GDP growth figure of about 0.5% QoQ, but we are mindful that PMIs have significantly overstated actual GDP growth in recent quarters.
A eurozone recession should be avoided, but fortunes will diverge on a country basis
Our economists have recently decided to lower their forecast for annual eurozone GDP growth to 2.5% in 2022 (from 2.8%) and 1.8% in 2023 (from 2.0%) due to weaker growth in China, tighter financial conditions, and continued bottlenecks. Their central scenario is that the eurozone as a whole can avoid a technical recession (two consecutive quarters of negative growth) this year, but some countries will fare better than others (France for example is better-positioned to weather the Ukrainian crisis than Germany or Italy for instance due to its more limited exposure to Russian energy imports and the French economy's lesser exposure to manufacturing).
Price pressures remain strong in the euro area, negotiated wage growth rising from 1.6% YoY in Q4 2021 to 2.8% in Q1 2022. This is likely to strengthen the ECB's resolve to tighten monetary policy, with the July rate hike virtually a ‘done deal’. ECB President Christine Lagarde’s latest blog post was one of explicit support for a July rate hike, followed by a second in September. Such would allow the ECB deposit rate to move out of negative territory "by the end of the third quarter". Consistent with this move toward policy normalization, Lagarde wrote that she expects net purchases under the ECB's asset purchase program to end "at the very beginning of the third quarter." Our economists expect three rate hikes (of 25 basis points each) by the ECB this year, bringing the deposit rate to 0.25%.
The median consensus is that EURUSD will move towards parity
The chart below shows economists' expectations for the trajectory of the EURUSD currency pair through Q1 2023. The recent risk-off in markets has clearly sparked a flight-to-safety trade in favour of the dollar (and at the expense of the euro). However, median consensus expectations continue to tell a tale of euro appreciation this year, to 1.10 against the US dollar by the end of Q2 2022; 1.13 in Q3 2022 and 1.17 in Q4 2022 (as illustrated in the bar chart below). Since our March update, the near-term consensus has become more bearish and the median expectation has dropped from 1.17 to 1.10 for Q2 22. On the other hand, the forecast for Q123 has moved only slightly and is pointing higher towards 1.20:
A relief rally in the euro may occur, but the long-term trend will remain negative for so long as the pair remains below its 200-day SMA (currently holding at around 1.13)
A look at the technical chart shows how the EURUSD pair has been in a correction phase since July 2021, when it fell below 1.18 (the 200-day moving average and the lower band of the bullish channel dating back to March 2020). The negative momentum accelerated, and the pair fell below a series of supports, including 1.12 (a level corresponding to the 61.8% Fibonacci retracement of the previous bullish channel set out in March 2020). Contrary to our analysis at the beginning of the year the negative momentum gained ground and the pair has now fallen below another technical support at 1.08, triggering a decline towards the low reached in 2016 at around 1.04.
Although the trend remains bearish (and has invalidated our prior scenario), there is some technical evidence to suggest that the pair is currently attempting to form a bottom, and indeed in the short term, a relief rally from oversold conditions has helped the pair recover towards the previous support at 1.08 (which has now become resistance).
A break above the 50-day SMA would brighten the technical outlook and pave the way for the pair to rise towards the next technical hurdle at around 1.11, the upper band of the bearish channel dating back to July 2021:
Equity consensus: the strategists’ view
2022 strategists have also since war broke out in Ukraine been revising their year-end targets on the Euro Stoxx 50 significantly lower (contrary to strategists in the US – as we discussed Wednesday). At the beginning of the year, the median analyst target on the index for year-end 2022 was 4,600. Less than five months later it has fallen to 4,070 (a downward revision of -11.7% and -1.9% since last year). Yet with the index currently trading at 3,674, such currently implies remaining upside performance of 11.6%:
On the short-term chart, the Euro Stoxx 50 has been forming a symmetrical triangle, a technical pattern that reflects uncertainty
The European index had formed a bullish channel dating back to its March 2020 low and appeared to be forming a classic Elliott 5 wave bullish sequence. Our initial scenario was to consider the 4,415 top (end 2021) as the target wave (3), and the correction in early 2022 the corrective wave (4). Since then however, the recent consolidation has sent the index below a series of supports, paving the way for a pullback below key support at around 3,870 (the pre-virus high and the 38.2% Fibonacci retracement of the wave (3)): the recent break of which invalidated our scenario; the negative price action paving the way for a decline towards 3,357 (the 50% Fibonacci retracement of the entire bullish sequence going back to March 2020).
Since then, we have seen a relief rally to previous support at 4,046, but the index failed to break through. In a second pullback the short-term support at 3,537 held, and the index has formed a higher high in the process.
In the short term, the index seems to have been forming a symmetrical triangle pattern; one which tends to reflect indecision and a market waiting for a break of resistance or support that might signal the direction of the next move.
A breakout of the resistance could trigger a rise towards 4,280 (a level corresponding to the height of the triangle and which would be above the consensus median 2022 target of 4,070):
Equity street consensus, the analysts’ view
While strategists tend to take more of a top-down approach, it is also possible to derive some implied target prices for indices by weight-averaging component index target prices made by analysts.
Application of this (“bottom up”) method implies that the analysts currently hold a more bullish view than the strategists, implying an upside move for the Euro Stoxx 50 of 32.1% (vs 11.6%). Only the DAX index is showing a higher distance to this target price than the average:
The technology and discretionary sectors have been the worst-performing sectors year-to-date (at -25.3% and -23.7% respectively). It is thus no surprise that they are currently trading at the greatest distance to median price target. On the other hand, the energy sector is up +32% in Europe since the beginning of the year and despite this strong performance, analysts are still seeing a comfortable 12.2% upside by year-end.
Equity street consensus, the analysts’ sector view
Focusing only on average target prices might result in an incomplete conclusion since a significant upside move may result from underperformance or a sharp drop in prices. For this reason, we have also aggregated the number of buy and sell recommendations issued by analysts as a percentage of total recommendations. Such bias is evident in the real estate sector which on this basis is showing 38.7% potential upside, but with a pessimistic analyst view on account of “only” 52.3% buy (and 15.7% sell) recommendations (as a percentage of total recommendations).
However, it is interesting to note that analysts appear to be particularly bullish on the consumer discretionary names and technology (despite the recent losses), as it is those sectors that currently have the highest percentage of buy ratings along with the highest average distance to sell-side target prices. This suggests that the current market weaknesses is not being driven by weakening fundamentals.
The conflict in Ukraine has clearly a significant impact on earnings revisions
War in Ukraine has encouraged strategists to revise their earnings expectations in Europe significantly. Since Russia invaded on 24 February, earnings sentiment (for which we use the difference between upward vs downward EPS revisions, scaled by the total number of revisions) across most European equity sectors has fallen, in sign that strategists have become concerned about the war's impact on revenues:
But as we discussed in our recent letter on the Q1 earnings season, companies have been quick in taking action to hedge and strategize to limit loses. The chart below illustrates the change in EPS revision breadth between before and after the 1Q earnings season. This triggered a new round of EPS upgrades that is summarized in the table below.
Out of the 11 GICS sectors, only real estate has seen a deterioration in EPS sentiment, and in absolute terms, only the real estate and discretionary sectors have suffered negative EPS sentiment on this basis. This is pretty supportive for the global price action over the short term as global revisions are being driven by most sectors:
Indeed, on a global basis Europe is the only region to have recently enjoyed a rebound in EPS sentiment. As shown in the graph below, such sentiment on the MSCI Emerging market and World indices has already turned negative (for the first time since March 2020). In the US, analyst sentiment is neutral (meaning that the pace of upgrades is matching downgrades). In Europe, sentiment has (somewhat unexpectedly) bounced back and the region is currently seeing 12% of net EPS upgrades:
Stock screening: EU sell-side top picks
We have screened European equities for those that carry analysts' strongest convictions for 2022 according to the percentage of buy recommendations and by average distance to target price. The consensus recommendation score is the aggregate of both components ranked from 1 to 5 (5 being the most “bullish” score):
On the other hand, below we present those names which are suffering the greatest number of analyst sell recommendations - and that are also expected to post a limited or negative performance for the rest of the year:
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