European stocks better reflect the coming slide in earnings than pricey US peers, according Citigroup Inc. strategists.
A team led by Robert Buckland raised European equities to overweight on Friday, saying valuations already discount a 15% drop in earnings. At the same time, they cut US shares to underweight on the grounds that earnings expectations are still too optimistic.
Citi’s view adds to growing optimism toward European stocks, which had their biggest outperformance on record versus the US in the fourth quarter following years in the doldrums. With recession now also looming in America, investors are turning their back on expensive mega caps and focusing on Europe’s cheap valuations. The Stoxx 600 Index trades at about 12.2 times forward earnings compared with the S&P 500’s 16.6 times.
In the US, “recession reality approaches,” the Citi strategists wrote in a note. “We expect a weaker first half, and a stronger second half.”
They forecast the S&P 500 will end 2023 at 4,000 points, implying about 5% upside from current levels, while predicting an 8% rise in the Stoxx 600 to 475 points.
The strategists expect global earnings to contract by 5% to 10% this year, as opposed to current analyst expectations for 3% growth, Buckland wrote. A Citi index shows analysts are already starting to moderate their expectations, with downgrades outpacing upgrades in both Europe and the US.
With major US banks including JPMorgan Chase & Co. and Bank of America Corp. kicking off the earnings season next week, investors will be assessing how higher rates, stubborn inflation and slowing demand have impacted corporate profits.
Buckland and his team expect rates to reach their highest in the first half of 2023, with cuts potentially coming later in the year. “A peak in rates would limit further valuation damage for equity markets,” they wrote.
Moreover, Citi’s Global Bear Market Checklist, which takes into account factors such as equity risk premium, fund flows and capital expenditure growth, is showing 6.5 out of 18 potential red flags, suggesting to buy the dip, but not chase rallies, Buckland said.
Separately, Goldman Sachs Group Inc. strategists led by Sharon Bell raised their 12-month price target on the Stoxx 600 to 465 points, implying 5.8% upside from Thursday’s close. Meanwhile, Societe Generale SA peers including Roland Kaloyan said that even though European equities now look expensive versus bonds, they would turn buyers if the benchmark trades closer to 400 points.
This article was provided by Bloomberg News.