Our Top Market Takeaways for February 10, 2023

Market update: The push and pull

Investors continue to feel the push and pull of an economy in transition. In all, U.S. stocks stand to end the week lower, and bond yields have risen roughly back to where they started the year.

Here’s what we learned:

  • Say what you want to say, but without saying what you want to say. This week saw a flurry of Fed speakers, with the main event from Chair Jerome Powell on Tuesday. Powell largely stuck to his script – disinflation has been promising, but there is a long way to go, and more hikes aren’t off the table. But it’s what he didn’t say that mattered most: despite last Friday’s blockbuster jobs report (which saw the U.S. economy add another 517,000 jobs in January), Powell didn’t suggest the Fed needed to hike above the 5.15% markets already expect. Read: rates are already restrictive, and the economy should continue to feel it.
  • Returning to normal? U.S. jobless claims rose for the first time since December. While the unemployment rate is at a historically low 3.4%, a tick up in claims suggests that the overwhelming demand for workers has a chance of coming back in balance with labor supply. Read: the labor market is still super tight, but is starting to move in the Fed’s direction.
  • Not terrible, not terrific. Q4 earnings reports this week echoed that mixed sentiment. Disney beat estimates, but saw poor streaming numbers and announced a round of layoffs to cut costs. Ride-hailing company Lyft missed expectations and said it expects fewer riders, while its rival Uber saw shares bounce on strong demand for rides and food delivery. A relative bright spot came from Pepsi, which showed the power of its brand and pricing power. Read: corporates are holding up, but also showing the slowdown.

But while U.S. markets wobbled, European stocks continued their climb. In dollar terms, the European market is on track for its seventh consecutive week in the green. Is the tide turning for Europe? Today’s Top Market Takeaways digs into five reasons why we think there might be cause for more optimism.

Spotlight: The case for Europe, in 5 reasons

Defying all odds, the outlook for Europe has continued to brighten. Here are five reasons we think the tide is turning.

1) Growth has been much better than expected — so much so that leading indicators are signalling expansion again.

While the region seemed to be teetering on the edge of recession heading into winter, improving energy dynamics have staved off the contraction most thought was inevitable. Thanks to a heroic effort to rebuild natural gas reserves and a milder than anticipated winter, natural gas prices have fallen by over 80% and are back at levels from before the war started. Europe looks to exit winter with better gas reserves (about 50% of capacity) than it would even in a normal year (about 30%). What’s more, Europe stands to reap tailwinds from China’s rapid reopening, given the economies’ trade linkages.

A milder winter had bolstered gas reserves

Finally, better still is that headline inflation looks like it’s slowing its roll — though we’d note the combination of still elevated prices and better growth are likely to keep the European Central Bank (ECB) hiking for now.

2) All those good vibes translate into more resilient earnings. Banks largely reported stellar profits, lower gas prices have been a boon for industrials companies like Infineon, energy companies like BP are increasing capital expenditure (capex) for new projects, and luxury brands like LVMH seem to be going from strength to strength.

Looking ahead, improved growth should boost sales, particularly as the Chinese consumer gets back in action. For instance, while Asia only accounted for about 11% of Stoxx Europe 600 revenues in 2010, it now represents more than 20%. Moreover, moderating prices should continue to ease some margin pressures.

Europes Geographical Revenue Exposure

3) We don’t think it’s all priced in. Even with an over 20% rally from the lows, we think there could be more room to run. European stocks are trading at a 13x forward price-to-earnings ratio, below its 14.5x 10-year average. We also expect Europe’s discount to the U.S. to continue to narrow. It was at a historically wide 30% before this rally and has closed to about 26% today, and we expect it to finish the year closer to 20%.

Europe Trades at a newar 30% discount to the U.S.

4) But it’s not just a short-term story — Europe is home to some of the growth trends of tomorrow.

This isn’t the same old Europe. The European market has seen its sector makeup shift from inherently lower growth industries like telecoms and banks toward higher quality companies like luxury goods and semiconductors. Further, as the pandemic and war exposed supply-side vulnerabilities, we believe that a capex cycle focused on developing the real economy is underway (think supply chain resiliency, energy and food security, infrastructure, and defense) — in stark departure from the era of low interest rates that fuelled mega cap tech in the last cycle. Such a shift could benefit Europe’s higher weighting to industrials, materials, and energy versus its U.S. peers.

5) A weaker dollar adds an extra kicker for U.S. investors.

The U.S. dollar has weakened about 10% from its highs as U.S. inflation cools, other developed world central banks catch up to the Fed’s rate hikes, and growth outside the U.S. has markedly improved. Meanwhile, the euro has rallied and the dynamics above should also give it further support. That means USD-based investors could see even more enhanced returns when investing in European assets. For example, since the start of October, the Stoxx Europe 600 has generated a compelling approximate 20% return in local currency terms, but an even higher about 30% in dollars!

Investment implications: Think outside the box

Europe accounts for only about 3% of U.S. investors’ total equity allocation, despite accounting for about 20% of the global equity universe. 2022 was also one of the worst years for flows out of European equities in the last decade. Many investors are underweight Europe, and looking ahead, while there remain risks around the war and the evolving business cycle, we believe the latest green shoots warrant a closer look.

In the multi-asset portfolios we manage, we've been increasing exposure. Some might also consider adding to broad markets with downside protection through structured notes. We likewise see opportunity in Europe’s national leaders across luxury, semiconductors and energy — many of which are aligned with policymakers’ priorities and may also provide stability in the face of any further volatility.

That said, at the same time, stresses remain, and a window appears to be opening for investors with expertise in special situations to acquire at assets at a discount and restructure troubled credit and real estate. Such strategies can generate yield and offer diversification if things go the other way.

Your J.P. Morgan team is here to discuss these insights and their impact on your portfolio.


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