Europe Insights Monthly update on European markets November 2018 Eurozone growth: slowing or stalling? Recent data have caused concern over the eurozone economic outlook. The area s GDP growth moderated in Q3, and renewed falls in business confidence in October may warrant further caution (see Data Watch page 4). Moreover, the introduction of new environmental regulation standards in Germany disrupted the Auto sector over the quarter. This has crystallised into a more general concern over the ability of the car industry to adapt to new business models. Meanwhile, foreign demand is slowing across goods, mainly driven by Chinese weakness. Slowing global trade growth and lagged impact of EUR strength, in addition to lingering threat of trade protectionism - including tariffs on autos - may be more persistent factors weighing on sentiment and investment. So the outcome for Europe may be to sign even more trade deals, as well as ensuring favorable financial conditions and fiscal policies to support investment for a smooth transition. Eurozone Auto sector a temporary issue Bottlenecks in the auto sector due to new environmental regulations in Germany explain most of the recent slowdown in manufacturing activity. The introduction of the Worldwide Light Vehicle Emissions Testing Protocol (WLTP) hit sales and production. Inventory clearing and aggressive pricing boosted car sales ahead of the regulation coming into force on 1 September. Then, in September, sales and production dipped amid bottlenecks in car certification, stockpiling and delivery delays (see graph 1). This temporary glitch in the auto sector exacerbated concerns over the eurozone economic outlook. However, the situation began reversing in October, which we believe bodes well for some degree of normalisation to return in the coming months. Graph 1. Slowing car sales volume in major world markets 12-month sum % YoY 20 10 0 - Eurozone China US Sources: Bloomberg, Thomson Reuters, China Association of Automobile manufacturers, US Bureau of Economic Analysis, end of Oct. 2018 This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination.
Eurozone growth: slowing or stalling? (contd.) Business investment maintaining direction The recent slowdown in the German auto sector has crystallised into a more general concern over the industry s ability to adapt to new business models The slowdown in the German auto sector has crystallised into a more general concern over the ability of the industry to adapt to new business models. Auto manufacturers need to adapt their business models to new environmental regulations and to a gradual shift to electric powertrains, driverless systems and connected cars. The development of new supply chains including the sourcing of batteries to power electric vehicles has hit firms margins in the short term. Changing business models and adapting to new regulations will require steady investment and research & development. As the product offerings develop, so will the demand for new cars. Meanwhile, policies to support the industry s transformation such as favourable financial conditions or fiscal incentives to boost compliance with new environmental rules will need to be monitored. Foreign demand China on the brake Volatility in eurozone auto sales has been driven by external factors, China s weakness since mid- 2018 and, more recently, the US car market slowdown At this stage, the recent volatility in eurozone auto sales has been driven by specific external factors, i.e. weakness in Chinese demand since mid-2018 and, more recently, a slowdown in the US car market (see graph 1 page 1). Total eurozone goods exports have weakened noticeably over the last 12 months, mainly driven by the drop in Chinese demand (see graph 2). China accounts for only 7% of total eurozone goods exports, but its robust expansion from May 2016 to October 2017 has decelerated rapidly since then. By contrast, eurozone goods exports to the US (14% of the total) have increased this year. Lingering protectionist trade threats, including auto tariffs, may have lately added to concerns, but in fact the outcome for Europe may be to sign even more trade deals. This could be supportive, since trade deals are designed to stimulate exports, as shown by the example of Canada even if it only represents 1% of total eurozone goods exports. The EU s recent deal with Japan (2% of total eurozone goods exports) will most likely provide a further boost (1). Graph 2. Eurozone goods exports in selected markets (value, 12-month sum % YoY) 20 10 0 - -10 Sources: Bloomberg, HSBC Global Asset Management, as of 10 October 2018 US China Canada Japan (1) The European Union s signed a trade deal with Canada on September 2017, and with Japan in July 2018. For more details on the EU current EU trade negotiations, see the European Union website http://ec.europa.eu/trade/policy/countries-and-regions/negotiations-and-agreements The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC. Consequently, HSBC will not be held responsible for any investment or disinvestment decision taken on the basis of the commentary and/or analysis in this document. The content of this page is not intended as an advice or recommendation to buy or sell any sector or financial instrument. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecast, projection or target. 2
Q3 European Earnings just don t seem to make the cut With 80% of European corporate earnings published so far, only a net 2% have missed the consensus. Eurozone earnings, on the other hand, are currently at 2% above consensus 20% 16% With 80% of European corporate earnings out so far, only a net 2% have missed the consensus. More precisely, 33% are above, 32% are in line, and 3% are below. Eurozone earnings, on the other hand, are currently at 2% above consensus. The final verdict is not out since 20% of companies haven t yet reported: the Real Estate sector, for example, has not released earnings but is widely expected to come out above consensus. On average, the market severely punished companies that missed earnings but without rewarding those that beat consensus either. For example, in the five days following their respective announcements, companies that missed by 10% to % were down 7.% relative to the market but those that beat it by 10% to % were down by 1%. In fact, only 2 sectors out of 11 have missed estimates so far Industrials & Consumer Discretionary. These earnings downgrades are mainly concentrated in cyclical export industries such as Autos, Capital Goods, Commercial and Professional Services, and Luxury Goods. They were all clearly hit by the slowdown in Chinese demand. For instance, China has represented over 60% of European passenger car sales growth. While reported earnings are not so bad, and sometimes due to one-off rather than structural trends, the market is clearly more focused on future uncertainty than on current results. Paradoxically, downgrades predominate in Growth and Mid caps (cyclical bias). Value companies like Banks largely beat the consensus. A plausible reason for this discrepancy is that margins for many Value companies have been close to trough levels for some time, while Growth companies such as IT and Luxury Goods are only just starting to feel margin and cost pressures. This could explain the underperformance of Growth compared to Value in September and October, after a long period of outperformance. Graph 3. Net % of Companies beating EPS Estimates 10% % 4% 0% -10% -8% -9% -20% Value Growth Large Small Mid Sources: Morgan Stanley Research, 12 November 2018 Sector Views Weighting* Rationale for our views Insurance Cheap valuations, and beneficiary of higher interest rates Telecoms Our overweight is predicated on very attractively valued companies following the recent correction Banks Enticing valuations; earnings growth is intact Healthcare & Equipment Our position is a result of stock choices and offsets our underweight in Pharmaceuticals Materials Our overweight results from the purchase of of Stora Enso which is an integrated paper, packaging, and forest products company Consumer Durables & Apparel Underweight The sector is composed of very expensive luxury goods companies Food, Beverage & Tobacco Underweight The sector is relatively expensive, defensive companies with low growth profiles Utilities Underweight We think very few companies present attractive fundamentals in this sector Semi-conductors Underweight After strong outperformance, this cyclical sector has become too expensive Real Estate Underweight Rising bond yields; relative valuations are unattractive to us * Position of HSBC Global Asset Management s European investment strategy in terms of key (OW) and Underweight (UW) versus MSCI Europe Sources: HSBC Global Asset Management/Factset/MSCI as of November 2018 The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC. Consequently, HSBC will not be held responsible for any investment or disinvestment decision taken on the basis of the commentary and/or analysis in this document. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecast, projection or target. Allocation is as at the date indicated, may not represent current or future allocation and is subject to change without prior notice. 3
Euro fixed income: outlook & positioning update We expect spreads to remain vulnerable but not to go much wider, ending the year around current levels Data watch as of November 2018 Indicator Data as of Latest data The year is ending amid some turbulence, with the balance between risk appetite and risk aversion swinging from one extreme to the other, and credit spreads widening further and further. Outlook. We expect spreads to remain vulnerable as many unresolved issues can be a source of volatility, so we remain cautiously positioned. However, we do not expect spreads to go much wider, but rather to end the year around current levels. We increased our exposure slightly at month-end as we found some good buying opportunities given that corporate fundamentals remain solid. Moody s drift ratio has been positive in Europe for 22 months running, while the cost of debt remains low. Defaults are set to remain low for a long time even if we re heading toward a later stage of the economic cycle. Positioning. We continue to favour our bottom-up asset selection strategy. We avoid peripheral names that are too exposed to their domestic market. In Italy, we still have no exposure to banks, which are the first to be affected by the spread of sovereign debt. We favour short-dated bonds with high premia as we maintain our scenario of a gradual normalisation of European rates. Consensus Previous data Analysis F: Final, A: Advanced, P: Preliminary estimate PMI Composite Oct. F 3.1 3.9 4.1 The composite PMI index declined to its lowest level since September 2016, mainly led by a slowdown in manufacturing output and in incoming orders. Both Italy and Germany recorded a slowdown, while France and Spain have seen resilient business activity. GDP Growth QoQ Q3 P 0.2% 0.4% 0.4% GDP growth unexpectedly slowed in Q3, driven by stagnation in Italy (0% vs. 0.2% in Q2) and contraction in Germany (-0.2% qoq against 0.% in Q2). Alternatively, GDP growth recovered in France (0.4% qoq vs. 0.2% previously) and remained robust in Spain (0.6% qoq, unchanged from Q2). Q3 GDP details will be released on 7 December. Industrial production (% YoY) Sept. 0.9% 0.3% 1.1% Industrial production surprised to the upside in August-Sept, but the trend since January has continued to weaken. Most of the weakness this quarter came from supply-side disruptions in the German auto sector due to new car emissions regulations which came into force on 1 September. Unemployment rate Sept. 8.1% 8.1% 8.1% Unemployment (now at 8.1%) has decreased rapidly since last December (8.6%). However, divergence persists across the region, with unemployment rates still above pre-crisis levels in a majority of countries, including France (9.3%), Spain (14.9%) and Italy (10.1%). Trade balance (goods, ex EMU) EUR billion (12mth cumulative) Sept. 209.3 212.2 220.0 The eurozone goods trade surplus has continued to decline over a 12- month period. Goods exports have decelerated (4.7% yoy from.1% yoy previously), while imports have stabilised (6.7% yoy). Retail sales % YoY Sept. 0.0% 0.1% 0.3% Retail sales surprised to the downside, with a slowdown in the 3-month trend to September, at 1.3% yoy in Q3 (against 1.7% yoy in Q2, 1.9% yoy in Q1 and 2.3% in 2017). Inflation (% YoY) Aug. A - Headline CPI 2.2% 2.2% 2.1% - Core CPI * 1.1% 1.1% 0.9% Headline inflation rose this month. Core inflation is now above its average of the past year (1% yoy), but still in its 0.6%-1.2% range seen since April 2013. Increasing wages and survey measures of firms and consumers inflation expectations suggest that core inflation will gradually rise, as the European Central Bank forecasts (1.% in 2019 and 1.8% in 2020). ECB Refinancing rate Deposit rate Asset Purchase Target - EUR bn/month 13 Sept. 0.00% 0.00% 0.00% 30 The European Central Bank (ECB) reiterated its intention to end its Asset Purchase Programme in December. The ECB aims at keeping large excess liquidity with no change in its balance sheet. It reiterated that policy rates will be maintained at their present levels at least through the summer of 2019 and in any case for as long as necessary. The next meeting is to be held on 13 December. Indicates improved or better-than-expected data on month-on-month/quarter-on-quarter basis Indicates worsened or below-expectations data on month-on-month/quarter-on-quarter basis Indicates unchanged or in line with expectations on month-on-month/quarter-on-quarter basis * Eurozone Core CPI is CPI excluding energy, food, alcohol & tobacco Source: Bloomberg, HSBC Global Asset Management, as of November 2018. The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC. Consequently, HSBC will not be held responsible for any investment or disinvestment decision taken on the basis of the commentary and/or analysis in this document. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecast, projection or target. 4
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