« Despite some small positive steps at the 28th post-2008 EU Summit, the EA crisis is
enduring and likely to get worse before better, with banking sector strains and deficit
overshoots. Our economists’ base case is 90% probability of Grexit over the next
12-18 months and they believe the most likely timeframe is in the next 2-3 quarters.
Over the next few years, the EA end-game is likely to be a mix of EMU exit
(Greece), a significant amount of sovereign debt and bank debt restructuring, and
only limited fiscal burden sharing. There’s plenty of news for investors to digest. »
« Macro – worsening trends
Global growth prospects are worsening, according to our economists, reflecting the
ongoing Euro Area crisis and slowing growth in EMs. They have recently cut their
GDP growth forecasts to 2.5% for 2012E.This includes Euro Area recession.
Overall, they still expect a soft, not hard, landing for the global economy but growth
will likely be sluggish over the next 12-18m and risks look skewed to the downside.
A slowdown of the global economy is likely to put ongoing pressure on corporate
profits. Domestic European growth headwinds should remain stronger than
international headwinds. We stick with our top-down earnings growth estimate of
0% for 2012E. This is broadly in line with weakened US and Euro Area PMI data.
We think European earnings growth will hit 0-10% in 2013E. Bottom-up earnings
growth expectations are heading lower but still look too high.
Valuation – support
European equity valuations look reasonably to very attractive to us. In absolute
terms, Europe trades on a 12-month forward P/E of 10x. This is 20% below its 25-
year average. On an EV/EBITDA basis, i.e. balance sheet-adjusted, UK and
European equities have not looked this cheap in the last 20 years. We continue to
argue that earnings (or margins) need to collapse to undermine the broad valuation
support for European equities. This probably needs a global recession, which we
think is unlikely in the next couple of years. But, it is also difficult to argue for a rerating
of equities in the near term unless various macro risks recede.
While there are plenty of macro risks across all regions, we see clear and stable
macro mega-trends in what is often an unclear and unstable world: 1) deleveraging,
2) lower growth, 3) divergence, and 4) low interest rates. We think that
these trends are embedded for the next few years. Our investment strategy
continues to be guided by this macro framework.
Our sector Overweights have an international and strong balance sheet bias. Our
sector Underweights have a domestic and more levered tilt. »