European Equity Strategy: Brexit breakdown

Redacción - Viernes, 24 de Junio

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 European Equity Strategy: Brexit breakdown
•   So it's Brexit. Dramatic risk off in markets is underway. Volatility to surge V2X to 40. Downside for Stoxx 600 16% vs y'day.
•   Our portfolio was set up for a Remain albeit with smaller sector bets. Today we cut Financials to u/w, cyclicals to neutral.
•   We add to our defensive o/ws in Utils and Pharma, eliminate u/w in Staples. Retail remains u/w with its large UK exposure.

UK has voted for Brexit - major risk-off move likely

We have repeatedly said that the risk on a Brexit was a volatile sell-off into illiquid markets. That is what we expect. Our economists expect a recession in the UK and a significant hit to Euro Area GDP over the next 12 months. We expect knock-on effects to the world economy too. All of which will likely hurt earnings. We modelled 16% downside for Stoxx 600 vs yesterday's close, based on previous Euro Area crises. That should take us through the lows of February. We expect the sell-off to be sustained due to an increased risk premium for European equities.

Equities to fall sharply, FTSE may outperform due to GBP

We think the FTSE stocks with large USD exposure may well outperform due to the likely sharp fall in the GBP. But it would only be on a relative basis. We do not think there are any absolute winners. Mid-cap UK is exposed to the UK economy and in our view will be vulnerable, as are European stocks, which are less protected by the EUR.

Volatility to spike and remain high

We see this as a global risk-off event. The USD is already strengthening which will likely put pressure on commodity prices. V2X vol we expect to revert back around 40. This is likely to spread over to other equity markets, with our US strategists seeing a 6-7% hit to the S&P. That spillover means that global equities will likely remain volatile for a time. While it may be tempting to buy the pullback, we would urge patience. The sell-off may go further than the market expects. Eventually though, we think value will attract buyers.

We cut Financials to underweight, Cyclicals to neutral

In our view, Financials are potentially the biggest victims of a Brexit because of both the financial and economic shocks. Despite the high yield in these sectors, we think further earnings downgrades are likely and we cut to underweight. Cyclicals are more tricky with our Global Wave having troughed. Some may also benefit from currency weakness. We think they will suffer from risk-off short term and we cut back to neutral.

Defensives the place to hide until vol subsides

We think investors will likely want to stay defensive until all of the volatility subsides and they have a view on the potential damage to growth. We raise Staples to neutral and add to our overweights in Utilities and Healthcare. We retain our Retail underweight on structural concerns.

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