Published: March 17, 2023 at 6:47 a.m. ET
One of the mysteries of the first two months of the year was that the US economy seemed to absorb a wave of Federal Reserve rate hikes without a problem.
After the events of the last two weeks, that notion can be put to bed. “Every rate hike cycle in the last 70 years has ended in recession (about 80% of the time) and/or a financial crisis (in 1984 and 1994),” says Graham Secker, chief European equity strategist for Morgan Stanley in London.
“ONE…
One of the mysteries of the first two months of the year was that the US economy seemed to absorb a wave of Federal Reserve rate hikes without a problem.
After the events of the last two weeks, that notion can be put to bed. “Every rate hike cycle in the last 70 years has ended in recession (about 80% of the time) and/or a financial crisis (in 1984 and 1994),” says Graham Secker, chief European equity strategist for Morgan Stanley in London.
“A week ago it was possible to argue that this sighting was theoretical, now we know it will be no different this time,” he added.
His comments came after three US banks collapsed as federal authorities ordered major banks to deposit $30 billion into First Republic Bank
FRC
to avert a fourth. Credit Suisse shares
CSGN
meanwhile, it’s down 22% this week on concerns about its survival.
Secker noted that financial crises do not always lead to economic recessions, as evidenced by 1984, 1987, 1994, and 1998. “However, at this stage, we believe that markets will run on the ‘guilty until proven innocent’ approach given: 1) the prospect of a significant tightening of credit availability and lending standards by banks following recent events;2) the deeply inverted yield curve going into recent events,” he said.
European stocks’ strong return in the year before last week was driven by financial and cyclical conditions. But now, he says, “we are convinced that the economic outlook has worsened and that the window for continued good/improving macro data is starting to close.” The firm upgraded the telecom sector to overweight as it also recommended “re-engaging in quality and other long-term ideas.”
Banks
SX7E
will be volatile, but the firm recommended selling to rallies while maintaining an overweight position in the sector. “It is impossible to determine how much of the European banks’ underperformance is due to concerns about changes in the net interest margin outlook versus contagion risk versus lower bond yields and interest rate expectations,” Secker said. “We believe that the latter factor has had a significant contribution and therefore any recovery here could lead to some upward volatility in the banks.”
A popular European exchange-traded fund, the Vanguard FTSE Europe ETF
VGK
,
is up 5% this year, slightly better than the S&P 500’s 3% gain
SPX
.
However, Secker says banking concerns undermine the case for European stocks relative to US ones.
“While we still see advantages in European equities versus global peers from a valuation and earnings perspective, a rotation away from ‘cyclical value’ and back towards ‘defensive/quality growth’ would not be consistent with the ongoing European outperformance,” he said.