The US guitarist John Mayer has a great song called “Stop this train” singing “I can’t take the speed it’s moving in”. That must sound familiar!
In today’s weekly, we thus ask ourselves what can stop this (US) long train running, led by the Magnificent 7. We also make two significant European sector adjustments (Luxury up, banks down).
US bull run: what’s driving it?
- AI: this is the key driver for a number of investors, who are saying: “Get me in”. This theme actually has a number of sub-drivers: booming earnings growth from Big Techs, driven by good costs control, advertising monetisation, and cloud growth. Hope: Hyper scalers announced massive investments in new infrastructures, which backs the idea that some big new applications are coming. Macro: a strong US consumer with no evidence of an imminent reversal.
- The Fed’s put is back in play: Despite the timing pushback, the Fed is also saying “Count on us to cut if the labour market worsens”. However, the more markets go up, the more the put is out of the money.
- Low diversification incentives reflected in the rising dollar: The strong US economy is supporting the dollar, and it has reduced the incentive to diversify away for global investors; at the same time, the eurozone economy remains stagnant, while China’s economic momentum continues to worry.
What can challenge that trend?
- Commercial real estate remains a hot topic considering the large exposure of small and mid sized banks. Default rates remain low but are rising fast.
- US economy running too hot/ oil prices jumping, forcing the Fed to make a U-turn on its December pivot; or conversely, some confirmation that the long-awaited “soft landing” is coming.
- US elections: uncertainty about the US elections could weigh on markets as Trump is unpredictable/ Biden too old.
- Price action: valuations are rich and an extreme level in the Nasdaq 100 could in itself trigger some profit taking. The technical configuration suggests March could favour profit taking.
Moving on to our MSCI Europe sector ratings, we downgrade Banks to Neutral.
- The earnings season has been very polarised with some car crashes on some of the large-cap stocks (BNP, ING) that were less subject to the risk of the “Net interest margin peak” theme. The theme of commercial real estate also weighs in the background even if European banks’ exposure seems limited.
- Later in the year with the prospects of an improving macro in Europe, we might see the sector outperforming again. Although we see some reasons for hope in the consumer driven recovery in Europe, the short term remains very fragile with very tight financial conditions.
- Strong shareholder returns and no signs of an imminent European macro collapse definitely limit the downside from here, hence our Neutral (and not UW).
We upgrade Luxury to OW.
- The fundamental backdrop is that the Luxury sector creates value over time and is a big earnings compounder. It’s also a European specific savoir-faire with no real competition, which makes it a structural buy.
- While it’s early days to be sure that margins don’t have more downside than currently expected, we note that analysts have turned very cautious about H1, implying a window for stocks to ignore some bad news. And indeed, the sector has started to react positively to bad news, which is usually a sign of valuation trough.
With wealth effects still working at full steam in the US, the sector could also welcome more significant pro-growth measures in China. In addition, we suspect that many investors won’t be able to buy China equities directly, and the luxury sector could be an obvious levered play on that theme.
Weekly asset classes performance (%)
