Deutsche Bank to Morgan Stanley Shun European Cyclical Stocks

  • Weaker China growth, slowing PMIs may hit tech, autos in 2018
  • ‘Significant sector rotation’ on the way, says Morgan Stanley

Some European equity strategists are betting the rally in stocks sensitive to the economy is nearing an end.

In their 2018 outlooks, Deutsche Bank AG and Morgan Stanley present underweight recommendations on European cyclical stocks, including the technology sector. Their calls come as the lead a gauge tracking the shares enjoys over its defensive counterpart holds near the biggest it’s been in 6 1/2 years -- a result of stronger global growth and expectations for stimulus from the U.S. administration.

The tide may be turning. Strategists at both banks say a weakening Chinese economy and a slowing pace of gains in global purchasing managers’ indexes means that tech and auto shares are among sectors that could suffer next year. Such a deceleration would be painful for a European equity market that gets roughly half its sales from outside the region.

Morgan Stanley also warns that cyclicals are particularly vulnerable to a reversal in momentum trades, which aim to profit from bets on existing market trends and are enjoying their best run since 2015. According to its analysis, European sectors over-represented in such strategies currently include materials, semiconductors, autos and luxury goods.

“In Europe, the sectors with momentum are basically cyclicals and tech -- those are the areas where we would be quite concerned,” London-based strategist Graham Secker said at a briefing Monday. “There is going to be a significant sector rotation, arguably in the next six months.”

According to a Deutsche Bank note earlier this month, its model of cyclicals versus defensives points to downside of about 10 percent for the former by the first quarter of next year. That’s around the time Morgan Stanley recommends investors consider taking some risk off the table.

The U.S. bank is instead bullish on energy stocks, which it says will be supported by rising oil prices, improving earnings revisions and valuations yet to respond to improving fundamentals. It’s also positive on banks and insurance. Its German peer upgraded European banks to benchmark from underweight “for now,” partly because it sees relative upside for euro-area PMI momentum until the end of February, before the measure fades.

“Our expectation that growth is set to soften from its current elevated levels leads us to be overweight defensives and underweight cyclicals,” Deutsche Bank strategists including Sebastian Raedler wrote in a note Monday.

— With assistance by Blaise Robinson

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