Weekly review 30 January 2023: Investors favouring European equities

1.2.2023

The earnings season is in full swing in the USA. This week, all eyes are on the central bank super week and data disclosures.

The upward trend in the investment markets continued last week. The Purchase Managers’ Indices (PMI) that measure business confidence strengthened in both the euro zone and the USA. Economic data overall has been stronger than expected in Europe, which can partly be explained by the lifting of Covid restrictions in China and the fall in energy prices thanks to a mild winter.

The past few years have seen investors leaning towards the US market, but the tide has recently turned in favour of European equities. Institutional investors, for example, are now clearly underweight in US equities and heavily overweight in European equities. The current underweight in US equities is the largest since 2005. In Europe, the stock prices of small caps have recently picked up and in the USA, growth company stocks have taken an upward U-turn.

The earnings season is in full swing in the USA, with around 28 per cent of US companies having reported their earnings. The earnings reported so far have been slightly better than expected, but they have contracted compared to the previous year. Companies’ earnings have contracted by approximately one per cent against the expected three per cent. The average net sales growth has been around +6 per cent. With inflation concurrently at 6.5%, the growth in net sales has been nominal. The raw materials companies that fared well last year have reported weaker earnings than a year ago, driven by declining raw material prices and rising labour costs. The earnings performance of energy companies has remained positive.

In Europe, the earnings season is just kicking off. The earnings reported so far have been rather weak, although only 10 per cent of companies have reported their earnings. The weakness of raw materials companies can also be seen in Europe.

Interest rate hikes expected from central banks

This week will be a central bank super week, with the US central bank (Fed) holding its interest rate meeting on Wednesday, followed by the European Central Bank and the Bank of England on Thursday. This week will also be eventful in terms of data disclosures.

With the easing of inflation, market expectations on key interest rate hikes in the USA have decreased. The markets expect the Fed meeting on Wednesday to raise the key interest rate by a quarter-point, i.e. 0.25 percentage points. Another similar hike is being priced in by the markets for the spring. The key interest rate is currently priced to peak at around 4.9 per cent. The markets expect the Fed to lower its key interest rates by 2–3 quarter-points as early as next autumn. However, a dramatic fall in interest rates would presumably require the economy to dive into a deeper recession, which does not seem likely at this point. Against this backdrop, the market expectations that the key interest rate will be cut any time soon may prove to be overly optimistic.

In the latest meeting of the European Central Bank (ECB) held in December, President Christine Lagarde announced that the ECB will stay the course of interest rate hikes. Consequently, the meeting on Thursday is expected to raise the rate by two quarter-points, i.e. 0.5 percentage points, and later by yet another quarter-point. The key interest rate is currently priced to peak at around 3.3 per cent, which is 5–6 quarter-points higher than today. The recent comments from the central bankers indicate that there is a rift within the ECB. Some of the bankers have reiterated Lagarde’s message of high inflation and the ensuing need to raise key interest rates, while some of them have stressed the monetary policy’s dependency on data, the easing inflation and the fact that decisions will be made one meeting at a time. Investors are therefore keen to find out whether Lagarde will soften her previous message at the Thursday meeting.

This week’s key data disclosures are the publication of preliminary data on January inflation in the euro zone on Wednesday (moderate cooling expected: headline inflation 9.0 per cent and core inflation 5.1 per cent), the publication of the US ISM manufacturing index on Wednesday (expectation 48.0; previous 48.4) and the publication of the US January labour market report on Friday.

 

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