European stocks will push higher over the next six months with banks providing the driving force, according to Bank of America Merrill Lynch strategists.
In a note published Thursday, BAML analysts, led by head of European equity strategy Sebastian Raedler, said the upside potential for European equities would be driven by positive euro area Purchasing Managers’ Index (PMI) momentum, and cyclical stocks outperforming defensives.
“In combination with our assumptions of moderately higher real bond yields, a fade in European policy uncertainty and mild headwinds from EUR upside, this implies a rise in the Stoxx 600 to 395 by year-end and 405 by next March,” the note said.
The pan-European blue chip index was trading at around 389.4 points late Thursday morning, but recovered to around 390.6 following the announcement of a massive stimulus package from the European Central Bank (ECB).
BAML is overweight European banks, on the premise that they tend to outperform the market when euro area PMI momentum is positive and German bund yields are rising. BAML analysis implies a 10% rise for banks’ share price by December this year.
After underperforming defensive stocks by almost 20% since mid-2018, European cyclicals have recently rebounded, and BAML believes the rally has further to go.
“Our analysis of European cyclicals versus defensives is based on Euro area PMIs, US bond yields and FX. Our assumptions of positive PMI momentum and bond yield upside are consistent with 5% upside for cyclicals versus defensives by early next year,” the note explained.
The note pointed out that pharmaceuticals in Europe typically underperform the market when U.S. 10-year Treasury yields rise and the dollar weakens, given the sector’s high U.S. sales exposure, and the BAML team is therefore underweight pharma.
“Our assumption for higher US bond yields implies this underperformance is set to continue, pointing to 5% downside for pharma’s price relative by early Q1,” the note added.
BAML is also overweight European mining stocks, based on an assumption of rising copper prices.
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