Improved outlook for European and industrial equities

Danske Bank has new recommendations for equity investors – the bank’s strategy team explains why.

While the number of corona infections is setting new daily records in the US and Europe right now, we are rapidly getting closer to a viable vaccine. US pharma giant Pfizer recently announced impressive test results and other pharmaceutical companies, too, are well on the way to developing vaccines.

This could provide an additional tailwind for European equities, in particular, in the time ahead. The European economy has been hit harder by lockdowns than the US and China, so Europe and European equities have a lot to gain from any future vaccine. Moreover, a vaccine could also boost the industrial sector, which is highly sensitive to the business cycle.

“That is why we have just increased the share of both European and industrial equities in our advisor portfolios,”says Danske Bank’s chief strategist, Henrik Drusebjerg.

If European equities suddenly take off ...

Looking at the regions first, European equities are lagging far behind Chinese and US equities due to both the more pronounced economic slowdown in Europe and also because the European equity market has a higher share of cyclical sectors like industrials, financials and energy. These are sectors that typically perform best during economic expansions and conversely suffer most during downturns.

“Once we really begin to emerge from the corona crisis sometime in 2021 and Brexit has hopefully been resolved, we expect to see an economic upswing that could boost the more cyclical parts of the European equity market in particular.”says Henrik Drusebjerg.

More specifically, Danske Bank has reduced its underweight in European equities and at the same time also reduced its overweight in US equities.

“Hence, our advisory portfolios no longer have a significant overweight in US equities, but rather just a modest overweight, and likewise we now have just a modest underweight in European equities. All in all, this reflects our view that US equities still hold the best return potential in the coming year, but that we have become less pessimistic in our view of European equities, and so want to have a better balance between the two regions – otherwise we would miss out too much if European equities suddenly take off,” explains the chief strategist.

He also notes that the European Central Bank has signalled more monetary policy easing in December.

“This could also help mitigate the negative effects of lockdowns in Europe and the downside risk for European equities,” he states.

Upswing winners

Turning to the sectors, cyclical sectors have, as mentioned, performed worst this year, as they tend to suffer most during an economic slowdown.

“However, we have seen a sector rotation in recent weeks, with investors increasingly turning to cyclical stocks and starting to position for better times ahead with higher growth and less uncertainty. We generally expect that this trend will continue, which is why we have raised industrials to overweight – in other words, we now have more industrial equities in our portfolios than we expect to have in the longer term. We already had an overweight in financials, where we also see an attractive potential when the economy picks up,”says Danske Bank’s investment strategist, Lars Skovgaard Andersen.

In contrast, Danske Bank has reduced the communication services sector from overweight to neutral, even though the sector has produced a decent return so far this year.

“Communication services encompass our digital needs and remains a sector with interesting long-term perspectives, just as there are still companies in the sector with an attractive return potential in the time ahead. However, in the shorter term, this could be one of the sectors that investors generally decide to offload in order to free up funds for more cyclical equities,” says Lars Skovgaard Andersen.

Best of both worlds

“The IT sector, too, could be hit by the ongoing sector rotation, but we are nevertheless maintaining our overweight here. First, because we see a pent-up investment need in IT – in other words, many companies can be expected to increase their investment in IT as the economy picks up. And second, the structural growth simply makes the sector very attractive – not least in these uncertain times that we still find ourselves in, even if we are beginning to see a light at the end of the tunnel. The same story applies to US equities, which history suggests is the equity market that provides the best hedge against uncertainty, and that is why we are maintaining an overweight here, even though the overweight has been reduced. While we increasingly see attractive investment opportunities in cyclical equities, we aim to select the best from both worlds,” says Lars Skovgaard Andersen.

Overall, Danske Bank continues to have a modest overweight in equities in its portfolios and an equivalent underweight in bonds.