Fog shrouds the Canary Wharf business district including global financial institutions Citigroup Inc, State Street Corporation, Barclays plc, HSBC Holdings plc and commercial office block No. 1 Canada Square on the Isle of Dogs in London, November 05, 2020. England.
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According to Willem Sells, global CIO at HSBC Private Banking and Wealth Management, investors should avoid allocating to Europe in search of value stocks, as the continent’s energy crisis means the risk-reward is not yet there.
The macroeconomic outlook in Europe is bleak as supply disruptions and the impact of Russia’s war in Ukraine dampen fuel and food price growth and force central banks to aggressively tighten monetary policy to rein in inflation.
Typically, investors turn to European markets in search of value stocks — companies that trade below their financial fundamentals — while trying to combat volatility by investing in stocks that offer stable long-term returns.
In contrast, the U.S. has an abundance of big-name growth stocks — companies expected to grow earnings at a faster rate than the industry average.
Although Europe is a cheaper market than the U.S., Sales suggests that the difference between the two in terms of price-to-earnings ratios — companies’ valuations based on their current share price relative to their earnings per share — doesn’t compensate for the extra risk you’re taking on. .”
“We think the emphasis should be on quality. If you’re looking for a style bias and are going to make a decision based on style, I think you shouldn’t look at the difference in quality between Europe and the US. It’s one of growth versus quality,” Sales told CNBC last week. said
“I actually don’t think clients and investors should allocate geographically based on style – I think they should do it based on your economic and your earnings outlook, so I would caution against buying Europe because of cheap valuations and interest rate movements.”
With earnings season set to begin in earnest next month, analysts widely expect a global earnings downgrade in the short term. Central banks are committed to raising interest rates to combat inflation and recognize that this could prompt economic strife and possibly recession.
“We see an economic slowdown, prolonged higher inflationary pressures and greater public and private spending to address the short-term consequences and long-term causes of the energy crisis,” said Nigel Bolton, co-CIO of BlackRock Fundamental Equities. .
However, in a fourth-quarter outlook report released Wednesday, Bolton suggested that stock pickers can try to capitalize on valuation differences across companies and regions, but they need to identify businesses that will help offset rising prices and rates.
He argued, for example, that buying of bank stocks intensified last quarter, as reports of expected inflation put more pressure on central banks to raise interest rates aggressively.
Beware of ‘gas guzzlers’
Europe is racing to diversify its energy supply, relying on Russian imports for 40% of its natural gas before the Ukraine invasion and subsequent sanctions. This need was exacerbated earlier this month when Russian state-owned gas giant Gazprom cut off the flow of gas to Europe through the Nord Stream 1 pipeline.
“The easiest way to mitigate the potential impact of gas shortages on portfolios is to be aware of companies with high energy bills as a percentage of revenue – especially where energy is not supplied by renewable sources,” Bolton said.
“The energy demand of the European chemical industry was 51 million tonnes of oil equivalent in 2019. More than one-third of this energy is supplied by gas, while less than 1% comes from renewables.”
Some larger companies may be able to weather periods of gas shortages by hedging fuel costs, meaning they pay below the daily “spot” price, Bolton highlighted. The ability to pass on incremental costs to consumers is also essential.
However, smaller companies without sophisticated hedging strategies or pricing capabilities may struggle, he suggests.
“We have to be especially careful when companies that may seem attractive because they’re ‘defensive’ — they’ve generated cash despite historically slow economic growth — have a significant, unchanged exposure to gas prices,” Bolton said.
“A mid-sized brewing company might expect alcohol sales to hold up during a recession, but if energy costs remain unchanged, it’s hard for investors to be confident about near-term earnings.”
BlackRock is focusing on Europe with globally diversified operations that insulate them from the impact of the continent’s gas crisis, while Bolton suggested that companies concentrated on the continent, with greater access to Nordic energy supplies, would fare better.
If price increases fail to meet gas demand and rationing becomes necessary in 2023, Bolton suggested that “strategically important industries” — renewable energy producers, military contractors, health care and aerospace companies — would be allowed to run at full capacity.
“In our view, supply-side reforms are needed to address inflation. That means spending on renewable energy projects to address higher energy costs,” Bolton said.
“This means companies may have to spend to strengthen supply chains and deal with rising labor costs. Companies that help other companies keep costs down will benefit if inflation lasts longer.”
BlackRock sees opportunities here for automation that lowers labor costs, along with those involved in the transition to electrification and renewable energy. In particular, Bolton predicted an increase in demand for raw materials such as semiconductors and copper to coincide with the boom in electric vehicles.