Last week's economic reports showed mixed results, but positive data from the US services sector and decent news flow from China boosted equities, while major bond yields continue to rise due to a reappraisal of the Fed's terminal interest rate and concerns of aggressive monetary policy tightening by the ECB. The outperformance of European equities remains very evident, supported by another very strong week in the Financials’ sector. We still believe that the divergence between equity valuations and rates is unlikely to be sustainable and would hence opt for defensive equity strategies in the expectation of deeper corrections ahead.
Our FX Strategy team has just published their flagship FX Insights publication. The USD (DXY) softening cycle has begun, but it won’t be a straight line. We hit the peak for USD in 2022, but the process is subject to multiple risks and fresh spurts. Inflation, the growth outlook and risk appetite will set the underlying tone for the USD in 2023, while individual central bank actions and geopolitics complete the full and potentially divergent picture.
There is no sign that the inflationary pressure in Europe is easing, as the signals suggest a well-defined levelling off remains elusive. Despite this disappointing result, it does not necessarily mean inflation is getting out of control. It must now be assumed (again) that the pace of adjustment will be slower than previously expected. The diagnosis is that: i) the ongoing moderation of the more volatile components (such as energy) is being offset in a few cases by YoY one-off base effects that are hampering the disinflationary process; and ii) the elasticity of core inflation to all this is also proving to be less than historically observed.
Actionable idea - ESG momentum: the EC presented its Green Deal Industrial Plan just over a month ago, to further place Europe and its net-zero industry at the forefront of a greener future, particularly in the wake of the US IRA passed last August. This should be a positive tailwind for sectors related to the EU's clean energy and technology value chain (e.g., renewable producers, raw materials suppliers and recyclers). EU Clean Energy & Tech is trading at reasonable prices of 15x forward P/E +12M, in line with its long-term historical average and at some discount to global benchmarks.
Actionable idea - Equity derivatives strategy: buy SX5E Jun23 4,500 call for 44.6pts (1.02% vs. 4,320.2 spot). The best time to hedge your fomo is at the bottom of an up-channel or resistance level. We prefer SX5E calls over SPX because they are about a vol pt cheaper and EU/US outperformance should continue given relative valuation (see below for more detail). June is a good expiry because we don't want to bleed theta if it turns out over the next week or two that the market does crash through supports and we have to take it off.