Fog covers the Canary Wharf business district including global financial institutions Citigroup Inc. and State Street Corp. and Barclays Plc, HSBC Holdings Plc and Commercial Office No. 1 Canada Square, at the Isle of Dogs on November 5, 2020 in London, England.
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Investors should avoid allocating to Europe in the hunt for stocks of value, as the continent’s energy crisis means the risk and reward are still lacking, according to Willem Sels, global head of information at HSBC Private Banking and Wealth Management.
The macroeconomic outlook in Europe looks bleak as supply disruptions and the impact of the Russian war in Ukraine on energy and food prices continue to stifle growth, and force central banks to tighten monetary policy aggressively to rein in inflation.
Investors typically turn to European markets in search of value stocks – companies that trade at a low price compared to their financial fundamentals – when trying to beat volatility by investing in stocks that provide a stable long-term income.
By contrast, the US offers an abundance of big-name growth stocks – companies are expected to turn in profits at a faster rate than the industry average.
Although Europe is a cheaper market than the United States, Sels suggested that the difference between the two in terms of price-to-earnings ratios – valuations of companies based on their current stock price relative to their earnings per share – does not “offset the additional risk they are taking”.
“We think the focus should be on quality. If you’re looking for style bias and you’re going to make the decision based on style, I think you should look at the quality difference between Europe and the US, rather than growth versus value one,” Sales told CNBC last week. .
“I don’t really think that clients and investors should consider doing geo-allocation based on style – I think they should do it based on your economic outlook and your earnings, so I would caution against buying Europe because of cheaper valuations and interest rate movements.”
With earnings season starting in earnest next month, analysts widely expect earnings cuts to dominate globally in the short term. Central banks remain committed to raising interest rates to counter inflation while recognizing that this could lead to economic conflict, and possibly a recession.
“We see an economic slowdown, higher inflationary pressures for a longer period, and increased public and private spending to address the short-term consequences and long-term causes of the energy crisis,” said Nigel Bolton, chief information officer at BlackRock Fundamental Equities. .
However, in his fourth-quarter outlook report published Wednesday, Bolton suggested that stock pickers can seek to take advantage of valuation differences across companies and regions, but will have to identify companies that will help provide solutions to higher prices and rates.
He argued, for example, that the case for buying bank stocks strengthened over the last quarter, as hotter-than-expected inflation reports put more pressure on central banks to continue aggressively raising interest rates.
Beware of “gas consumers”
Europe is racing to diversify its energy supplies, having relied on Russian imports for 40% of its natural gas before the invasion of Ukraine and subsequent sanctions. This need was exacerbated early this month when Russia’s state-owned gas giant Gazprom cut off gas flow to Europe via the Nord Stream 1 pipeline.
“The simplest way to mitigate the potential impact of gas shortages on wallets is to be aware of companies with higher energy bills as a percentage of income — especially when energy is not supplied from renewable sources,” Bolton said.
“The energy needs of the European chemical industry were equivalent to 51 million tons of oil in 2019. More than a third of this energy is provided by gas, while less than 1% comes from renewables.”
Bolton explained that some large companies may be able to withstand a period of gas shortages by hedging their energy costs, which means they pay less than the daily “spot” rate. Also essential is the ability to pass on higher costs to consumers.
However, he suggested that smaller companies that do not have sophisticated hedging techniques or pricing power may encounter difficulties.
“We should be particularly wary when companies that may appear attractive because they are ‘defensive’ – which have historically generated liquidity despite slow economic growth – are highly exposed and unprotected to gas prices,” Bolton said.
“A mid-sized brewing company may expect alcohol sales to hold during the recession, but if energy costs are not hedged, it is difficult for investors to be confident in their near-term earnings.”
BlackRock focuses on companies in Europe with globally diversified operations that shield it from the impact of the continent’s gas crisis, while Bolton noted that among companies focused on the continent, companies with greater access to Nordic energy supplies would fare better. .
If price increases fail to ease gas demand and rationing becomes necessary in 2023, Bolton suggested that companies in “strategically important industries” — renewable energy producers, military contractors, healthcare companies and aviation — would be allowed to operate at full capacity.
“Supply-side reform is necessary to tackle inflation, in our view,” Bolton said. “That means spending on renewable energy projects to address higher energy costs.”
“It also means that businesses may have to spend to strengthen supply chains and tackle rising labor costs. Businesses that help other businesses keep costs down are set to benefit if inflation stays higher for longer.”
BlackRock sees opportunities here in automation that reduces labor costs, along with those involved in electrification and the transition of renewable energy. In particular, Bolton predicted rising demand for semiconductors and raw materials such as copper to keep pace with the electric car boom.
from San Jose News Bulletin https://sjnewsbulletin.com/hsbc-warns-investors-to-avoid-european-stocks-in-search-of-value/
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