JPMorgan: there is a better risk-reward in Eurozone equities

Here’s the summary of their views:

« In November of last year we moved US equities from OW to UW in our global portfolio, benefitting Eurozone which we switched from UW to OW. If equities are to advance further in ‘15, which is still our base case, we do not believe that US equities will remain the leaders.

Some of the arguments that make us concerned about the US, in the relative sense, are the following:

1. Fed’s liquidity support is finished. Its balance sheet as a share of GDP is starting to decline.

2. Profit margins are at record highs, with early indications that cost base is moving up. Oil price was typically positively correlated to market earnings; material downgrades to Energy sector are still pending.

3. Strong USD is likely to be an increasing headwind for corporates.

4. A lot of good news is in the price, S&P500 tripled from the ’09 lows.

5. Bullishness on the direction of US equities is fully consensus – not a single sell side house is calling for S&P500 to be down this year.

6. US appears to be fully owned in global portfolios.

7. US HY credit has rolled over, opening the gap with stocks.

In contrast, we think that Eurozone now offers a better risk-reward: activity appears to be bottoming out just as ECB is about to act more aggressively, and the benefits of weaker Euro are coming. In the report we outline a detailed analysis of how equities tended to
trade as the QE started. All three iterations of QE in the US have seen Cyclicals outperform, in particular Discretionary and Industrials. Exporters worked also. Energy, Telcos and Utilities were the laggards. Within Financials, Banks didn’t work, but Insurance did.

Dax remains our key OW and we are positive on export baskets. Among Cyclicals, Consumer Discretionary stays our top OW. We prefer core to periphery, but we note that a big gap has opened up between peripheral equities and bonds now. Peripheral stocks should start catching up in Q1, perhaps after Greek elections are out of the way.

So far ytd SX5E is up a bit, while the SPX is down. However, we find it difficult to believe that Eurozone equities will show a significant directional decoupling from the US. The US and Eurozone have historically moved directionally together 83% of the time. Interestingly
though, Eurozone did not tend to be a high beta on the way down.

Our view is that global equities will be up this year. Within this, and in contrast to the consensus view, we don’t see Eurozone as the main driver of uncertainty. The key risks to our positioning are that: US equities end up being weak, and the worsening credit overhang in EM. »

To charts help build the positive view on eurozone equities according to the bank:

Source: JPMorgan

Source: JPMorgan

Says the bank:

« Eurozone equities have derated sharply and are now trading at the lowest P/E relative to the US in more than a year. »

Source: JPMorgan

Source: JPMorgan

« A leading indicator for Eurozone activity that we use is money supply. We think that the turn higher in Eurozone PMIs and in IFO in December should be extrapolated. »

Another lead to EZ expected outperformance is the expansion of credit growth:

« Credit activity also appears to be bottoming out, with private loan growth almost back to zero in November, yoy. Consumer credit turned outright positive at the end of ‘14, for the first time in more than 5 years. »


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