Deutsche Bank’s strategist team published a report to figure out what’s currently priced in by financial markets after the bout of volatility. Rising real yields are a clear threat to the rebound in equity market. But having recently talked to fund managers in other asset classes, real yields are a threat to many asset classes where lots of money have flown other the last years (EM debt for instance).
Here’s DB’s take on European equities:
« The recent equity market correction in the US and Europe was due to rising real rates: A key reason for the sell-off in the US equity market was the rise in real bond yields, caused by more hawkish central bank rhetoric. Moves in the US P/E tend to move inversely to the 2-year real US rate. Over the past three months, the US real rate has risen by over 60bps, the sharpest rise since mid-2015, implying a drop of around 8% in US P/Es versus an actual de-rating of 4%. In Europe, the correction was less sharp, given that real bond yields have risen by less: the 10-year Euro area real bond yields is up around 20bps over the past three months, implying around 4% de-rating, while the actual P/E is down 3% over that period.
What is priced in for European equities? Our tactical model for European equities, based on real rates as well as PMI momentum, FX and a proxy of political uncertainty, suggests the Stoxx 600, at 375, is trading around 7% below the current fair-value, at 400. The market is thus effectively already priced for a softening in growth momentum or a further rise in real bond yields. (…)
The main downside risk relative to these forecasts is that real bond yields keep rising. If real bond yields were to rise by another 50bps by mid-year, as implied by our rates’ strategists Bund yield projection, this would lower the implied fair- value of our tactical model to around 350 (7% downside from current levels). If, on the other hand, growth momentum remains at its current elevated levels, our tactical model points to a fair-value level of around 380 for the Stoxx 600 by mid-year. »