Bank of America explains how it's adjusting its European stock portfolio as COVID-19 variants threaten global growth
By: Business Insider
July 28, 2021 at 04:45 AM EDT
Yann Schreiber/Contributor/Getty ImagesSummary List Placement
The world is increasingly eager to forget about COVID-19 forever. But it's too soon to put the pandemic in the rearview mirror, as the highly contagious Delta variant threatens to derail global growth and dent stocks in the US, China, and especially Europe.
That's according to Bank of America, which downgraded European stocks to neutral from positive as it cut its exposure to cyclical stocks. Growth in Europe and around the globe probably peaked in May, as measured by the Purchasing Manager's Index (PMI), the firm said.
"We expect global growth momentum to remain robust in Q3, but the downside risks are rising," a team of BofA investment strategists led by Sebastian Raedler wrote in a July 23 note. "... The probability of a meaningful re-acceleration in growth is fading."
European equities, as measured by the Stoxx 600, are up a solid 14.6% in 2021 but have flatlined since mid-June. BofA said there's upside of just 3-4% for the index through August, but added that a projected rise in bond yields, which helps economically sensitive sectors like financials, could provide "one last leg of rates upside" for cyclical stocks.
BofA is getting more defensive, trimming exposure to European capital goods while upgrading European utilities to market-weight from underweight after the sector lagged by 20% since March 2020. However, it's still lukewarm on bond-proxy sectors like health care and consumer staples, and is underweight both. The firm also announced a downgrade of diversified financials to market-weight from overweight.
These latest downgrades are in stark contrast to Bank of America's bullishness regarding European equities as recently as a few weeks ago.
"European banks remain compelling reflation candidates given their cheap valuations, long-run underperformance to global peers, and a better entry level afforded by post [Federal Open Market Committee] weakness," a team of BofA analysts wrote in a June 29 note.
BofA's July Fund Manager Survey [FMS] revealed that a net 20% of investors said European stocks were undervalued. Allocation to Eurozone stocks grew to 45% net overweight — the highest mark since January 2018 — and Europe was the "#1 regional long" idea.
"The July FMS shows that investor positioning relative to history is still very much tilted toward cyclicals such as Eurozone, industrials, materials, while defensives exposure has been cut again," wrote Michael Hartnett, BofA's chief investment strategist, in a July 13 note.
The biggest reason for the turnaround in sentiment from prior weeks is the rapidly spreading Delta variant of COVID-19, which Raedler said should curb Europe's growth in Q3. BofA economists project Eurozone GDP growth to rise 8% quarter-on-quarter annualized in Q3, which is slightly more pessimistic than the consensus estimate of 10%.
"Our economists worry about downside risks to their growth projections, given the recent sharper-than-expected rebound in new daily COVID-19 infections on the back of the spread of the Delta variant," Raedler wrote. "... A number of countries have started to re-impose restrictions (albeit mild ones for now). They also caution that rising case counts could lead to more cautious consumer behavior and increased sick leave, again hampering the growth rebound."
Investors can follow Bank of America's upgrades by balancing out their portfolio and adding exposure to European utilities with the SPDR MSCI Europe Utilities UCITS ETF (UTIL:LN).
NOW WATCH: Why some Coca-Cola bottles have a yellow cap