20181204-法国巴黎银行-Q1_2019_EQUITY_OUTLOOK_A_CHANGE_OF_AIR_62页_3mb

Q1 2019 EQUITY OUTLOOK: A CHANGE OF AIR

Core Content Summary

Macro Overview

• Opportunities in 2019: Earnings growth, particularly in small and mid-cap European equities, is expected to drive equity market performance. The US and Japanese markets are viewed with caution.
• Increased Volatility: 2019 is anticipated to be a more volatile year, with higher volatility in the US due to late-cycle dynamics and in Europe due to political risks, especially around the European Parliament elections.
• Global Equities: The market is expected to see a rise in equity volatility, with the effect of higher bond yields on equities fading. Equity risk premia have risen since the start of 2018, independent of bond yields.

Inflation and Equity Performance

• Inflation as a Positive: Rising inflation can benefit value stocks and support equity earnings, at least while it remains below 5%. In the US, inflation in the 1–3% range has historically led to higher equity valuations.
• Equity-Credit Relationship: Even with rising bond yields, equities can recover. Late-cycle periods with yield increases have shown positive equity performance, indicating that inflationary pressures may not be a direct headwind.
• Value Factor Recovery: Inflation could drive a recovery in the European Value style, with free cash flow and EBIT-based valuation metrics being more effective than traditional ones like price/book or price/earnings.

Geopolitical Risks

• Eurozone Geopolitical Risk Index: The index has been at high levels for almost 20 weeks and is expected to normalize, historically associated with equity market upside.
• Brexit Impact: The UK domestic market may underperform due to uncertainty, while the FTSE could benefit from GBP under pressure.
• European Elections: The elections on 23–26 May may favor anti-establishment parties, potentially leading to early Italian elections and recession risk.

Key Trade Ideas

• Dividends: Long 1x DEDZ1 and short 0.6x DEDZ4.
• QARP Basket: Long BNP Paribas Buyback QARP basket (BNPPBOT4 Index) vs short European High Leverage basket (BNPPEHL1).
• Volatility Strategies: Long Dec20/Dec21 offered at 17.2vols (SX5E put option strategy), and hedging NKY with Jun20 90/110% collar.
• Tail Hedging: SPX put contingent on higher 10yr swap rates and SPX and TLT best of put for inflation risk.
• Forward Variance: Long Dec19/20 SPX forward variance at 21.4.
• Cross-Benchmark Trades: Long CSI300 vs short HSCEI to hedge against a range-bound market.

Sector Outlook

• Energy Sector: Strong fundamentals and earnings growth are expected due to rising oil prices and limited OPEC spare capacity. The European energy sector offers attractive valuations.
• Banking Sector: Potential outperformance due to higher interest rates and a normalization of geopolitical risk, which could reduce uncertainty and improve bank valuations.

Key Themes and Insights

Inflation's Role

• Inflation supports equity earnings and can drive a recovery in the Value style, particularly in Europe.
• The relationship between inflation and equities is not linear, with higher inflation potentially increasing discount rates but also boosting earnings.
• The energy sector is particularly sensitive to inflation and could benefit from a rebound in oil prices.

Volatility Outlook

• The term structure of volatility has been flat after the October sell-off, with mid- to long-term vols under pressure.
• The US is expected to see a sustained trend in higher volatility due to late-cycle earnings downgrades.
• In Europe, political risks are likely to be a major driver of volatility, especially around the elections.

Geopolitical Risks

• The BNP Paribas geopolitical risk index is expected to normalize, which historically correlates with equity market upside.
• Brexit uncertainty and Italian politics remain key risks, with potential for a no-deal outcome and early elections.
• The US-China trade dispute is still a concern, though there is a possibility of easing tensions.

Equity-Credit Dynamics

• Rising bond yields and credit spreads may not necessarily lead to a sell-off in equities.
• The Value factor is expected to outperform as inflation rises, with a positive correlation to macroeconomic momentum.

Conclusion

The outlook for 2019 suggests a mix of opportunities and risks across global equity markets. Europe is seen as a more promising region for equity growth, driven by earnings momentum and a potential recovery in the Value style. The US and Japan face more caution due to margin pressures and uncertain macroeconomic conditions. Geopolitical risks, especially in Europe, are expected to normalize, potentially leading to equity market upside. Inflation, while a concern, may support equity valuations and earnings, especially in cyclical sectors like energy and banking. Investors are advised to consider hedging strategies and tail risk protection, particularly through volatility and dividend instruments.