Citi: The 15 + 26 shares in Europe that will overcome fears of a recession and are a great buying opportunity

Of Eleftheria Kourtali

High inflation, rising interest rates and geopolitics have affected the stock market in 2022, according to Citigroup in today’s report on European markets, with the Stoxx 600 index falling by 15% since the beginning of the year. However, it seems that investors’ concerns are now turning to the prospect of an economic slowdown, even a recession. Thus, the American bank identifies those shares that are expected to outperform during the current period when the worries about the course of growth have hit “red”

As he notes, the monetary tightening led to the yields on nominal and real bonds to increase sharply in 2022. US 10-year government bonds are at 3.2%, having started the year at 1.5%. Yields on 10-year US bond inflation (TIPS) are at + 0.6%, up from -1.0% at the beginning of the year. This year’s de-rating of stocks, especially “growth” stocks, has closely followed the increase in real returns.

Indeed, as of 2018, 70% of P / E is explained by the level of real US returns. The UK, with its strong propensity for value stocks, was less sensitive. Luxury goods are now the largest trade of real performance in Europe. Other trades include technology, retail, chemicals and industrial products.

Citi bond market analysts believe that growing concerns about a recession will limit future bond yields. They estimate that the nominal yields on 10-year US bonds and the yields on TIPs will close the year around current levels. This suggests that the worst of the de-rating of “growth” stocks in Europe may be over. For example, the current 12-month P / E of the luxury goods industry (19x) is already lower than the 20x forecast for Citi’s 10-year TIPS. Overall, valuations in the European market are already consistent with 10-year TIPS yields of 1.0%, which suggests that the room for further decline in European stocks is now limited.

Those who agree with Citi analysts that the big increases in bond yields are over should start looking at “growth” stocks in Europe, according to the US bank. For those who believe that more aggressive central banks could drive real yields even higher, then “growth” stocks may have less room to fall than their US counterparts.

The “growth” stocks that will beat the market

So if investors agree with Citi general interest rate analysts that the peak of central bank aggression is now measured in bond yields, then the de-rating of “growth” stocks may be over. “Maybe it’s time to dive back into Europe ‘s growth stocks,” said Citi, which is examining MSCI Europe for growth stocks that have been hit hard by rising real yields in 2022.

It thus identifies 15 stocks that have proven to be historically defensive, with earnings per share being more resilient in the previous four periods of significant decline in the profitability of listed companies, and are in the industries, information technology and luxury goods. These are:

These 15 shares have yielded 18% of the total European market since the beginning of 2022, down 29% from 13% for the pan-European index. These stocks, however, tend to have better yields at times when fears of a recession are rising, but bond yields are slowing. This seems to be the most likely macroeconomic scenario for the second half of 2022, as noted by Citi.

As he points out, the forecasts for the profitability of European companies are strong. The consensus places the increase in EPS this year at 15%. However, according to the American bank, these forecasts are very optimistic and it sees an increase of only 3% this year and 4% in 2023. However, he notes, some market participants expect worse, fearing the economic downturn and a significant contraction in EPS.

Citi economists still expect 2.5% GDP growth in the eurozone this year, but believe the chances of recession increasing. How vulnerable could EPS be if there is an economic contraction? During the last 4 European recessions, EPS fell by an average of 30% in 20 months. So far, after peaking in March, EPS have fallen by only 1%.

Are there cheap defense stocks? Citi identifies 26 buying opportunities

Citi is looking at these last 4 major recessions to identify those defensive stocks that have proven resilient and whose EPS have not fallen more than half of the total market.

He notes that the European stock market has fallen the most since the 2011 crisis in the Eurozone. The pan-European Stoxx 600 has seen a significant de-rating with the P / E falling to 12x below the long-term average of 14x. However, this is not yet very extreme. During the European crisis of 2011 the P / E fell to 9x.

Although it is difficult to find cheap defensive stocks, Citi manages to find 26 of the MSCI Europe Index which are trading at a discount against international stocks and are showing resilient EPS during periods of recession. These are found in the utilities, telecommunications, pharmaceuticals and insurance sectors, and are: