From a domestic standpoint, the idiosyncratic
issues that weighed on growth in 2H18 are now starting to fade. Consumer confidence is rising again in
France as the gilets jaunes protests lose much of their intensity, and the German auto sector is showing
signs of recovery, with both order intake and passenger car registrations rebounding strongly in the last
couple of months. In addition, financial conditions across the euro area have eased dramatically over the
past three months, wage growth continues to climb and our economists project that 2019 will bring the
largest fiscal stimulus the region has seen since 2009.
Looking beyond domestic
considerations, we believe that a fair share of Europe’s slowdown last year was ‘made in China’. The
sharp drop in growth there weighed heavily on Europe, given its sensitivity to trade and exports, and we
would caution investors not to underestimate linkages between the two regions. In a recent report, we
highlighted that the China PMI new export orders series leads the euro area PMI closely by about three
months, while China credit growth tends to be a solid predictor of Morgan Stanley’s European EPS growth
lead indicator. Perhaps most striking of all, we found that European banks’ relative performance has
correlated more closely with Chinese bond yields than European bond yields over the last five years!
Hence our bullish call on China suggests a better outcome for Europe in the months ahead.
sceptics on Europe, this may sound like a rather large dose of wishful thinking, but we’ve already seen
better euro area retail sales and PMI data for February, implying that January marked the trough for data
in this mini-cycle. Given the depth of poor investor sentiment towards the region, any confirmation that
growth is rebounding is likely to have important and positive implications for asset prices. With CFTC
data suggesting that positioning in EUR is close to a three-year low, we are bullish on EURUSD and target
a rebound to 1.18 by the summer. With yield differentials close to record wides, we are underweight
European government bonds relative to North American bonds and still see scope for Bund yields to reach
50bp by year-end. And with relative valuations close to an all-time low, we also prefer European equities
to US equities. We note that post a trough in the euro area PMI, the average increase in European
equities over the subsequent six months is 9%.
• Our global equity strategists remain constructive for stocks in 2019. They believe that the four key
drivers of the turn in risk sentiment: the Fed, USD, trade fears and China stimulus, are all tracking
favourably. It is the case that some tactical indicators started to look toppy, but our strategists
argued that one should use any weakness as the opportunity to add further. The pain trade remains on the
upside, in their view. This is because the positioning in equities continues to be light, where the flows
have lagged the price moves. Also, they highlight that equities always start rebounding significantly
before the inflection in the earnings revisions is evident. The market vs earnings lead-lag in ’98, ’03,
’09 and ’16 was between 5 and 10 months, with stocks up around 30% before fundamentals turn, and with
very clear market internals, Cyclicals have lead Defensives on each of those instances. Fundamentally,
they believe the earnings and PMIs will confirm the rally as we move into 2H. In their weekly, they
addressed another pushback from bears – the fears over the declining money supply measures. M1 has been
falling in all the key regions since the beginning of last year, however, the China and US M1 data are
likely to inflect higher imminently. They note that M1 tends to be inversely correlated to Fed moves, and
as Fed goes on a prolonged hold, the downside pressure on US M1 should reduce. Regionally their top picks
remain China and the US.
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