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Europe 1Q Equity Shifts, FTSE Rallies on Dovish Outlook

European equities face sector rotation challenge; FTSE 100 rallies amid rate cut expectations, outperforming with a 20% undervaluation.

By Athena Xu

5/15, 06:51 EDT

Key Takeaway

  • European equity portfolios face challenges from a shift to defensive sectors, impacting previously successful tech and consumer-discretionary investments.
  • Market dynamics in Europe are changing, with geopolitical tensions and higher interest rates affecting stock performance drivers.
  • The FTSE 100's rally is supported by the Bank of England's dovish monetary policy outlook, hinting at potential rate cuts.

Sector Rotation Challenges

European equity portfolios that benefited from overweight positions in technology and consumer-discretionary sectors during the first quarter of 2024 are now facing challenges due to a shift towards defensive sectors such as utilities and energy since early April. Bloomberg Intelligence European Equity Strategist Laurent Douillet highlighted the difficulty in maintaining alpha generation amidst this sector rotation. Despite half of the analyzed funds (with €32 billion in assets under management) outperforming the MSCI Europe by 200 basis points on average in the first quarter, only two funds have managed to continue this outperformance, albeit marginally by 10-20 basis points, since April. Growth portfolios that initially surpassed the index by 120-380 basis points in the first quarter have since underperformed.

Market Dynamics Shift

The European equity markets are witnessing a significant shift in investment drivers due to long-term geopolitical tensions, higher interest rates, and the energy transition. These factors have diminished the influence of earnings per share (EPS) estimate revisions and target-price changes on stock performance, which were once among the best investment drivers for European equities. Laurent Douillet, Bloomberg Intelligence European Equity Analyst, noted that the Q-spread returns have reduced to 2-3% over a 29-month period, a stark contrast to the 200% long-short returns seen over the previous 12 years. This shift has led investors to focus more on value and cash-distribution factors.

FTSE 100's Rally and Monetary Policy

The FTSE 100 index has shown a record-setting performance, narrowing the gap with its US and European counterparts. This rally is attributed to the perceived undervaluation of UK equities, a positive outlook on commodities, and the performance of major companies such as HSBC, AstraZeneca, oil giants, and miners. The Bank of England's dovish stance, as indicated by Governor Andrew Bailey, suggests potential for interest rate cuts, which could further bolster the FTSE 100's growth prospects. Traders are expecting around 60 basis points of cuts by the end of the year, with the index being significantly below its calculated fair value, indicating a 20% undervaluation.

Street Views

  • Laurent Douillet, Bloomberg Intelligence (Neutral on European equities):

    "European equity portfolios face a sector-rotation challenge, with those boosted by overweight technology and consumer-discretionary positions in 1Q now wrong-footed by defensives (utilities, energy) gaining favor since early April."