Investing.com -- Bank of America strategists project a decline in Europe’s Stoxx 600 of approximately 10% from its current highs by mid-year, noting that the cyclicals in the region may be nearing a peak after a strong recent comeback.
European cyclical sectors have rebounded by approximately 15% since September, driven by a resurgence in luxury goods, continued strength in capital goods, and a pullback in sectors like pharma and food & beverages.
While global growth is expected to remain robust and bond yields to drift higher, BofA cautions there could be a softening in global growth momentum. This could lead to a 3.5-point drop in the global composite Purchasing Managers' Index (PMI) new orders from the current 52.5 to 49 by mid-year, which would likely result in negative global macro surprises and an increase in global risk premia from current compressed levels.
“This matters for cyclicals versus defensives, given that cyclicals tend to roll over when global PMIs fade, global macro surprises turn negative and risk premia widen,” BofA strategists said in a note.
“What is more, we see scope for a combination of negative macro surprises and well-behaved US inflation, in line with the projections from our US economists, to translate into a renewed fade in bond yields,” they added.
“Taken together, our macro assumptions suggest cyclicals versus defensives should be close to a peak, with potential for a 15% pull-back into the summer, leaving us underweight.”
In terms of sectoral impact, capital goods and construction materials are seen as vulnerable to a potential increase in risk premia due to their strong negative correlation with US high-yield credit spreads.
On the other hand, cyclical sectors that still appear attractive include semiconductors and chemicals due to their historical relationships with global and China PMIs and bond yields.
Among defensive sectors, BofA highlights pharmaceuticals, which is seen as potentially undervalued after its recent pullback, with relative earnings per share (EPS) momentum at a four-year high.
Similarly, food & beverages and utilities are expected to benefit from any widening in risk premia and a fade in bond yields.
Despite a negative outlook on European equities overall, BofA strategists still see scope for continued tactical outperformance in European stocks relative to global equities, supported by a projected improvement in Euro area PMIs.
European small caps could outperform large caps, and quality stocks are expected to outperform the market, while value stocks could underperform if bond yields fade as anticipated.