Global equities outlook
The recovery of the equities market since the beginning of the year has benefitted from two factors. On the one hand, even though macro data remains weak, it has struggled at low levels. Macro momentum (the six-month change in the US ISM) has turned slightly less negative as a result, marking a turning point in equity performance in Q4 2022. On the other hand, rates have stabilised, removing a key pressure point on valuations, which could result in re-rating and a move back up to levels last seen in Q2 2022.
Despite the stabilisation of these key drivers, the market rebound has been extremely narrow. The seven largest stocks in the S&P 500 have delivered all of the performance since the beginning of the year, with less than a quarter of S&P 500 stocks outperforming year-to-date. Tech and tech-related stocks have been the dominant force driving the market higher over recent months, bringing the relative valuations of tech back to their highest levels since the early 2000s. The two previous times that tech stocks were priced similarly to today (relative to the market), were in November 2007 and December 2021. Both times, the equity market was on the cusp of a multi-month sell-off. This is not to say that this will happen this time around, but it is an indication that the market stands on a fragile footing, with little assurance that the recent rally will continue.
From a fundamental point of view, what keeps us cautious is the renewed deterioration in US macro data in May, especially] on the services side. A pocket of strength in recent months, the US services ISM fell sharply in May and brought the three-month moving average back to levels only touched during recessions. This decline not only sends a warning signal about the health of the US consumer, but also implies that US GDP growth has slowed sharply in the second quarter. Other data performed slightly better in the US (e.g. labour market numbers), keeping macro surprises in positive territory, while they have slipped in Europe. Macro surprises in the Eurozone have fallen from a two-year high in January to their lowest level since mid-2022.
Given that Eurozone equities are more cyclical and more domestically oriented economy than equities in any other region, they closely track Eurozone macro surprises. From a tactical perspective, the recent slump implies a more sustained underperformance relative to global equities.
While we place Eurozone equities at the bottom of our preference list, we think there is value in the Eurozone real estate equity sector. We have moved the sector to “most preferred” given that it is already priced for a decline in house prices, which has yet to materialise. Even with a 35% correction in the sector's home prices and book value, it would still look attractive. Furthermore, the sector tends to benefit from falling rates more than any other sector in the Eurozone market. Given our base case, which predicts that yields in the US and Europe will fall over the next 12 months, real estate equities stand to benefit.
Staying with European equites, we believe there is a strong case for defensive stocks in the Eurozone to outperform cyclicals in the Eurozone (ex tech sectors), as macro data has started to weaken once again, implying some more sustained weakness in cyclicals.
Lastly, we have lowered our year-end target for Chinese equities, but believe they still have room to catch up with fundamentals. Political risk has been a headwind in recent months and continues to weigh heavily on the market. While we do not expect a significant escalation in tensions between the US and China, there is still reason to be cautious when it comes to increasing China's exposure.
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