According to Oddo BHF Asset Management’s global CIO, valuations of European stocks are often already cheap, but not cheap enough to justify large increases in positions. Things are already looking better in other segments.
© Oddo BHF Asset Management
For Laurent Denize, Global CIO of Odoo BHF, despite recent lows in the STOXX 600 since the Covid crisis, appropriate entry points have not yet been reached to re-enter European equities significantly. In a recent market assessment, he warns that investment decisions should never be made solely on the basis of valuations. European stocks remain exposed to the growing risks of a global recession due to tighter financing conditions and aggressive central bank policies. “Even with significant pessimism already priced in, rising real interest rates continue to weigh on risk premiums. There is also a risk that the implied risk premium for global equities will fall back to their long-term average with the planned future rate hikes from the ECB. With this in mente, we believe it makes sense to wait for the STOXX600 to fall below 360 points before repositioning into European equities on a large scale,” writes Denize.
Ratings – extreme levels significant
For the performance of an investment over a 30-year period, it makes almost no difference whether the price/earnings ratio at entry is above or below the historical valuation average of the STOXX 600 with a price/earnings (P/E) ratio of 14. “However, the assessment is important when extreme levels have been reached. If you buy the STOXX 600 below 10 times earnings, there is an 82% historical probability of positive performance over the next 12 months, an average of 18%,” writes Denize. To reach this attractive entry point, the STOXX 600 must fall by at least five percent, i.e. below the 360 point mark.
Focus on robust cash flows
In this environment of geopolitical uncertainty and rising interest rates, Denize believes that the priority should be predictability and robustness in cash flow. “Not only does the healthcare sector generally benefit from a strong dollar, it also offers an attractive risk-reward ratio.” Thus, several large European pharmaceutical companies (AstraZeneca, Roche, Merck) will be able to increase their sales by four in the coming years, increase by up to five percent, achieve good margins and offer appropriate valuations accordingly.
Within the technology sector, the software/IT services sub-segment (Cap Gemini, SAP) is once again more attractive following the fall in valuations. “Digital transformation remains high on the agenda for large companies looking to become more agile and competitive in the face of inflationary, logistical and economic uncertainty.”
Large software companies can also increase their recurring revenue by switching to cloud solutions. “Capital-intensive and highly leveraged sectors with limited pricing, such as the telecommunications industry and regulated utilities, we remain cautious. Despite attractive valuations, we believe it is still too early to enter sectors such as consumer goods and industrials, as the downward adjustment of earnings expectations has not yet gone far enough,” writes Oddo BHF AM’s chief investment strategist.
Corporate bonds as an alternative to shares
“Although the risk of a recession is rising, European corporate bonds represent an interesting alternative to equities in the short term,” says Denize. The segment is also attractive compared to European government bonds, and yields offer significant yield premiums compared to government bonds of the same duration.
Within the bond segment, high yield bonds offer a yield profile that approaches that of equities over the long term. Bonds with the highest credit quality and a rating of BB dominate the euro area’s high yield universe. With a yield to maturity (YTM) of 6.6 percent, they are 480 basis points above the interest rate on three-year German Bunds. For comparison: the risk premium for shares is 7.4 percent. Denize: “For the first time in many years, bonds offer some benefits.” (aa)