Costliest Growth Bets in 2 Years Turn Sour for Europe Stocksby and
Sectors that led rally forecast to post biggest profit drops
Goldman Sachs warns of performance gap among cyclical sectors
The recent rally in European companies most dependent on the economy is unwarranted given the risks in global growth.
That’s the message that firms including JPMorgan Chase & Co. and Morgan Stanley are sending, after valuations of cyclical companies reached a two-year high relative to defensive bets. For the first time since May, cyclicals fell last week while shares deemed safer rose, as Chinese data renewed concern over the health of the worldwide recovery.
As the earnings season gains steam, skepticism is returning. Mixed economic results, plus concerns about financial firms and the future of central-bank policy are threatening the stocks that investors had been betting on. Analysts are calling for an earnings contraction this year, and commodity producers and banks -- those that have led the rally in cyclicals -- are the ones forecast to post the biggest slumps.
“The market has been pricing in a too optimistic environment,” said Emmanuel Cau, an equity strategist at JPMorgan in London. “The global economy is just not picking up materially. Investors have gotten a bit ahead of themselves.”
The Stoxx Europe 600 Optimised Cyclicals Index, comprised of financial firms such as Banco Santander SA, engineering giant Siemens AG and miner Rio Tinto Group, has rallied 17 percent from a low in June, almost five times more than a similar gauge tracking defensive companies. That’s pushed their valuation to more than 13 times estimated earnings, near the highest since November 2014 relative to defensives.
Both the cyclicals and defensives index fell on Monday, with the Stoxx 600 down 0.4 percent at 8:23 a.m. in London.
While euro-area data are back to beating forecasts, economists project growth will slow to just 1.5 percent this year and 1.3 percent next, from 2 percent in 2015. Analysts estimate earnings at lenders and commodity producers will be the most hurt among Stoxx Europe 600 Index industries. They’re calling for a contraction of more than 17 percent for them this year, compared with a 4.5 percent slide for members of the broader index, data compiled by Bloomberg show.
“The significant rotation into cyclicals in recent months suggests European equities are now more vulnerable to any disappointment,” Morgan Stanley strategists wrote in a note dated Oct. 13.
In a report last month, Goldman Sachs Group Inc. warned about the risks of betting on cyclical companies, which include industries ranging from finance to technology and industrials that can have wide gaps in performance. The difference in returns for each sector has been the largest since 2008 this year, average monthly data compiled by Bloomberg show. The biggest gainers and losers are both cyclical industries, with miners surging 35 percent while banks tumbled 22 percent.
“These huge divergences between sectors reflect the fact that investors are switching very quickly,” said Peter Dixon, a global equities economist at Commerzbank AG in London. “They’re unsure of which trend to follow as we have a lack of clarity on what’s happening.”