Europe Equity Research
07 December 2009Mislav Matejka, CFA(44-20) email@example.com
Given that developed world equity markets have rebounded almost 60% over the pastfew quarters, it might be tempting to project lackluster equity performance for 2010.After all, the pushbacks remain numerous. The equity valuation cushion has erodedwith stocks trading at mid-cycle multiples, analyst EPS growth expectations appearpunchy at face value, the consumer backdrop remains challenging, credit crunchaftershocks linger, there is likelihood of EM policy normalization ahead of the DMand the possibility of a more dramatic bond sell-off, capping equity performance,along the lines of the 1994 experience.
Despite this, we believe equities will deliver significant further gains in 2010,and look for 20% upside.
We find investors to be skeptical regarding the durabilityof the unfolding economic recovery, but our view is that it will have legs, with animprovement in labour markets confirming its sustainability. In addition, thestabilization in the credit markets, signs of house prices troughing, steep yield curveand the rebound in corporate profitability are the positives.The consensus European EPS growth expectations for the next two years call for 40-50% cumulative growth, which we think is achievable looking at the patterns of pastrebounds and the relatively high profit margins at the trough. Equity valuations haverecovered back to long-term averages, but we think there is a potential for furthermultiple expansion if the positive growth–inflation tradeoff prevails, where developedworld central banks remain accommodative for longer, and inflation remains subdued.In terms of trajectory, we think the 1st half of the year offers the better risk-reward,while the interest rate uncertainty might start hurting equity performance in the 2ndhalf.Last December we advocated a rotation into Cyclicals out of Defensives, with toppick Basic Resources (seeYA 2009). We continue to expect the outperformance of
Cyclicals in 2010, but to a much lower extent than over the past few quarters. Webelieve relative earnings momentum will again become an important driver of performance, as well as the outlook on pricing margins, spreads between outputprices and input costs. In addition, we think the yield compression theme will favourselected high yielding parts of the market. We prefer continental to UK stocks.
The Year Ahead process
The goal of this document is to present our key strategy themes for 2010 using ouranalysts’ most and least favoured stocks.The process started with the Strategy Team briefing analysts on the key themes for2010 and macro-economic forecasts. Working within this established framework,analysts then presented their top picks and stocks to avoid to their sector heads.The sector heads then filtered out key long and short ideas, which were presented tothe Strategy Team. These stock ideas form the heart of this report.
JPM index target forecasts
Target Current* %
MSCI Europe 1300 1085 20%MSCI EMU 185 153 21%FTSE 100 6150 5246 17%
Source: Datastream, JPMorgan; Equity targetsare based on 2011 EPS integer, and forecastedend 2010 12M forward P/E multiple * as at27/11/2009
Risk-Reward remains positivefor stocksExpect 20% EPS growth in 2010and 15% in 2011Potential for further P/E re-ratingYield compression to supportrotation into equities in 2010Cyclicals outperformance tocontinue, albeit smaller than in’0977 Analysts11 Macro teams22 Sector teams