China news boosts case for European cyclical stocks: Read By Investing.com

Investing.com — Chinese authorities have introduced several key measures to support the economy, including cuts in monetary policy rates and reserve requirements, as well as initiatives to lower mortgage rates, particularly for first and second homes , Citi Research analysts said. in a note.

A new equity market support facility has also been introduced. While some of these moves were expected, such as policy rate cuts and mortgage repricing, others came as surprises.

The upcoming 25-50 basis point reduction in RRR and reduction in down payment requirements for second homes caught the market off guard.

These steps, combined with new mechanisms to support the equity market, have spurred a surge in Chinese and China-exposed stocks.

Despite this positive market response, Citi economists caution that these policy measures are not enough on their own to reshape China’s long-term growth trajectory.

The underlying problem remains weak credit demand, rather than liquidity constraints, meaning that more robust fiscal support may be needed to significantly alter the growth outlook.

“Therefore, Citi economists maintain their 2024E growth forecast for China at 4.7%, implying that Beijing’s GDP growth target remains at risk,” analysts at Citi Research said.

However, these recent developments tilt the risk balance progressively towards sectors that are more sensitive to cycles.

In Europe, this shift is particularly significant for industries with strong ties to China. European shares linked to China have come under heavy pressure throughout the year, underperforming both the overall index and the index.

Key sectors such as luxury goods, IT, autos and basic resources were hit hard by declining earnings and declining valuation.

Citi analysis shows that earnings expectations for China-sensitive European stocks have been revised down by about 10% for 2024, five times the cut seen in the broader market.

Furthermore, forward price-to-earnings ratios for these stocks fell by about 7%, even as the overall market saw these ratios rise. Any stabilization in China could therefore provide relief to these sectors, making them prime candidates for a recovery.

One element of Citi’s analysis is the contrarian signal arising from significant earnings downgrades. Citi’s Earnings Revision Index (ERI) for MSCI Europe fell to -39%, while the European Cyclical Index fell further to -50%.

Historically, such extreme negative readings have often been followed by market rallies. On average, the MSCI Europe index tends to rise 13% in the year following a sub-40% decline in ERI, with cyclical stocks outperforming defensive stocks by around 10% over the same period.

This suggests that, despite recent challenges, there may be significant growth potential for Europe’s cyclical sectors.

Rate cuts, both in Europe and globally, tend to support equity markets, especially outside of major recessions or financial crises.

Cyclical stocks, in particular, have historically outperformed their defensive counterparts during periods of monetary easing. As central banks, including the US Federal Reserve, move towards a more accommodative stance, cyclical sectors could benefit from the favorable environment.

In addition, seasonal trends often favor cyclical values ​​heading into the end of the year, adding further impetus to trade.

Against this backdrop, Citi has adjusted its European sector strategy to reflect a more balanced, or ‘barbell’, approach. While maintaining overweight positions in defensive growth sectors such as technology and healthcare, Citi has selectively increased its exposure to cyclical stocks.

In recent weeks, Citi upgraded the auto sector to a “neutral” rating, reflecting improved sentiment around China’s policy support.

Similarly, basic resources were also upgraded to Neutral as the outlook for stabilization in China begins to improve the outlook for commodities.

At the same time, Citi reduced its exposure to more defensive areas, downgrading food and beverages and moving telecoms to an underweight rating, as these sectors are expected to face headwinds amid an improving cyclical environment.

Citi analysts remain cautious on China’s overall growth outlook, noting that without more substantial fiscal intervention, the country’s economy could continue to face headwinds.

However, the recent wave of policy easing, while not transformational, offers a degree of optimism that could be particularly beneficial for European cyclical sectors.