Deutsche Bank Sees Signs of Exhaustion in Europe Cyclical Rally

(Bloomberg) -- The record-beating rally of European cyclical stocks is heading for a pause.

That’s according to Deutsche Bank’s head of European equity strategy Sebastian Raedler, who argues that equities geared to the economy will underperform defensive peers by about 10 percent through mid-year. Sectors like banks and miners -- which last year benefited from investor optimism over growth -- will bear the brunt of slowing economic momentum in Europe and globally, he said by phone.

Recent data lends some support to Raedler’s argument. The Purchasing Managers’ Index for euro-area manufacturing fell for a second month in February, with IHS Markit noting that a slowdown in export orders to the weakest level in almost a year means growth could moderate.

“People may say purchasing manager indexes are still at very high levels, but the simple answer is that the rate of change in growth momentum is by far the strongest determinant of equity performance, not the level itself,” Raedler said. “The crucial question is whether you focus on the level or the rate of change, which is turning negative in Europe. For us, it’s the rate of change.”

Deutsche Bank Sees Signs of Exhaustion in Europe Cyclical Rally

The slowdown is part of the reason that European equities have struggled more than U.S. peers in the aftermath of the February selloff, a trend Raedler says will continue. His year-end target for the Stoxx Europe 600 Index is 395, about 5 percent lower than an average of 413 in a Bloomberg survey of equity strategists.

Deutsche Bank is also underweight European value stocks relative to growth peers. That’s a contrarian call at a time when others are calling for a revival in value, which tends to benefit when bond yields rise. But Raedler’s model based on euro-area PMI momentum suggests the level of the German 10-year government bond yield has reached a peak.

“Our projections for a fade in global PMI momentum, with particular risks in Europe and China, points to downside for European value versus growth,” he said.

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