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High Hopes and Poor Outlook Create Storm Clouds

The resilience of the market is likely built on rate-cut expectations, JPMorgan strategists write.

High Hopes and Poor Outlook Create Storm Clouds
Clouds gather above buildings at night in Seoul, South Korea. (Photographer: SeongJoon Cho/Bloomberg)

(Bloomberg) -- Europe’s equity benchmark has been moving within a tight range over the past five sessions. Trade wars, geopolitical instability and poor global macro data are spurring concerns, yet there’s been no big sell-off. It seems that investors are counting on the Fed to save the day tomorrow with a rate cut.

European stocks tend to react positively to a first U.S. rate cut in a cycle, as they have typically risen by 2% in the month that follows, according to Goldman Sachs strategists. It’s not a given though, as it occurred only two-thirds of the time. On the other hand, the euro rose in 77% of the cases, Goldman says.

High Hopes and Poor Outlook Create Storm Clouds

Traders seem to have already priced in at least one cut before the end of the year, even if economists are still debating the timing. The implied probability of a 25 basis point cut has moved to almost 100% today.

The resilience of the market is likely built on rate-cut expectations, JPMorgan strategists write, which makes it vulnerable to a sell-off if the Fed this week doesn’t give a strong indication of a rate cut. The central bank needs to show it’s ahead of the curve, especially with the upcoming G-20 meeting (June 28-29) and the very low likelihood of positive trade talks between the U.S and China, they say.

Meanwhile, the economy has been sending more warnings signals. The U.S. jobs market is showing signs of fatigue, U.S. macro surprises have come down, and remain negative in Europe. Yesterday’s Fed Empire manufacturing index had a record fall, hitting its lowest level since 2016.

High Hopes and Poor Outlook Create Storm Clouds

This month, the Morgan Stanley Business Conditions Index plummeted to its lowest level since 2008, a bad omen for the ISM manufacturing index and thus the S&P 500, Morgan Stanley says. Should the historical relationship hold, this would mean the S&P could drop 8% from current levels. And that would have a ripple effect on European stocks.

High Hopes and Poor Outlook Create Storm Clouds

The business index is also indicative of future revisions to earnings, as it’s driven by analyst surveys. The trend seems to have started already if you look at the Citigroup’s Earnings Revision Index, with expectations for companies’ results dropping in a similar fashion to the second half of last year.

High Hopes and Poor Outlook Create Storm Clouds

The Fed’s reaction to the deteriorating outlook will be closely watched on Wednesday, and the big question remains over what it can do to support the market. Failure to act could send stocks into a perfect storm.

In the meantime, Euro Stoxx 50 futures are trading down 0.2% ahead of the open.

  • Watch oil companies after softer U.S. economic numbers hit the oil price as crude traders continue to balance out supply assurances and demand concerns. It appears OPEC is having trouble agreeing when it will meet next. Iran faces yet more criticism from U.S. politicians following its threat about breaching enriched uranium caps and President Trump decided to send more troops to the Middle East.
  • Watch the pound and U.K. stocks as Boris Johnson remains the frontrunner but outsider Rory Stewart appears to have made waves. Separately, a Bloomberg survey shows economists expect a stagnant U.K. economy in the second quarter.

COMMENT:

  • “After the strong rebound since the start of the month, we think risks remain symmetric near term given a potential disappointment from the Fed and the ongoing uncertainty on US/China trade tensions,” Goldman Strategists write in a note. “We prefer to position via options near term as the risk of larger equity drawdowns remains elevated. Our options strategists prefer S&P 500 collars given the low level of skew.”

COMPANY NEWS AND M&A:

  • Airbus Jumps Ahead With New Jet in Paris While Boeing Flounders
    • American Air Mulls Ordering Up to 50 of Airbus’s New A321XLR Jet
  • Infineon Says Shares Placed at EU13.70, Gross Proceeds EU1.55b
  • Scania CEO Says Margin Will Increase in Coming Quarters: DI
  • EU28 May Car Registrations Rise 0.1% Y/y to 1.401m Units
  • Swedbank’s Estonian Unit Replaces CEO, CFO After Internal Probe
  • Ageas Got More Claims Than Expected in Fortis Settlement: FD
  • Short Sellers Circle Blue Prism After 2,200% Rally Since IPO
  • Hutchison Chi-Med Is Said to Delay Launch of Hong Kong Listing
  • Tieto to Acquire Evry for NOK35.48/Share in Cash, Share Deal
  • Italy’s UBI Mandates KPMG to Find Single Insurance Partner: Sole
  • CGG Wins Multi-Year Processing Contract From Adnoc
  • Nordex Gets 300 MW Order From Engie Unit
  • Dassault Systemes Lead Investor in EU65m BioSerenity Financing
  • Deoleo Reaches Agreement to Refinance EU553M Debt: Confidencial
  • Ambu Cuts FY Outlook and Lowers Mid-Term Targets After Review
  • Vapiano Sees 2019 Net Sales Missing Estimates, Slower Expansion

NOTES FROM THE SELL SIDE:

  • BBVA and CaixaBank are the stand-out names in a Spanish banking sector contending with lower-for-longer Euribor rates and muted domestic loan growth, RBC analysts write in a note. CaixaBank, BBVA both at outperform; Santander also outperform with Sabadell and Bankinter at sector perform and Bankia at underperform.
  • Citi cut Evraz to sell at Citi. Broker cut the former top pick and CEEMEA focus list member as Ebitda and free cash flow are “sharply declining.”
  • European hotel operators with headroom on their balance sheets are likely to focus on making acquisitions given slowing organic growth in the industry, Citi says in a note. Broker has buy rating on Accor due to exposure to Europe and France, the only regions showing RevPAR growth; sell on IHG given heavy U.S. exposure, and neutral on Whitbread but as single brand operator is likely to be of interest to a private equity buyer.

TECHNICAL OUTLOOK for Stoxx 600 index:

  • Resistance at 382 (50-DMA); 385.7 (61.8% Fibo)
  • Support at 374.5 (61.8% Fibo); 368.2 (200-DMA)
  • RSI: 51.2

TECHNICAL OUTLOOK for Euro Stoxx 50 index:

  • Resistance at 3,408 (50-DMA); 3,514 (May high)
  • Support at 3,309 (50% Fibo); 3,266 (200-DMA)
  • RSI: 52

MAIN RESEARCH AND RATING CHANGES:
UPGRADES:

  • Accor Upgraded to Outperform at Bernstein; PT Set to 44 Euros
  • Danone upgraded to outperform at Davy
  • Tokmanni Group upgraded to buy at Handelsbanken; PT 9.30 Euros

DOWNGRADES:

  • Avesoro Resources downgraded to hold at Berenberg
  • Bauer cut to hold at Kepler Cheuvreux; Price Target 22 Euros
  • Derwent London cut to underweight at Barclays; PT 30 Pounds
  • Evraz downgraded to sell at Citi
  • Evraz Cut to Hold at VTB Capital; Price Target 6.70 Pounds
  • Homeserve cut to equal-weight at Barclays; PT 13.20 Pounds
  • InterContinental Hotels cut to underweight at Barclays
  • Lufthansa downgraded to hold at HSBC; PT 16.50 Euros
  • Lufthansa Downgraded to Hold at SocGen; PT 17 Euros

INITIATIONS:

  • STMicroelectronics rated new buy at SocGen; PT 23.60 Euros
  • Veolia rated new outperform at MainFirst; PT 24.70 Euros

MARKETS:

  • MSCI Asia Pacific down 0.4%, Nikkei 225 down 0.9%
  • S&P 500 up 0.1%, Dow up 0.1%, Nasdaq up 0.6%
  • Euro up 0.16% at $1.1236
  • Dollar Index down 0.15% at 97.41
  • Yen up 0.24% at 108.28
  • Brent little changed at $60.9/bbl, WTI down 0.1% to $51.9/bbl
  • LME 3m Copper little changed at $5843.5/MT
  • Gold spot up 0.4% at $1345.5/oz
  • US 10Yr yield down 2bps at 2.07%

ECONOMIC DATA (All times CET):

  • 8:45am: (IT) Bloomberg June Italy Economic Survey
  • 9am: (SP) 1Q Labour Costs YoY, prior 0.9%
  • 9:30am: (UK) Bloomberg June United Kingdom Economic Survey
  • 11am: (EC) April Trade Balance SA, est. 17b, prior 17.9b
  • 11am: (EC) April Trade Balance NSA, prior 22.5b
  • 11am: (EC) May CPI Core YoY, est. 0.8%, prior 0.8%
  • 11am: (EC) May CPI MoM, est. 0.2%, prior 0.7%
  • 11am: (EC) May CPI YoY, est. 1.2%
  • 11am: (GE) June ZEW Survey Current Situation, est. 6.1, prior 8.2
  • 11am: (GE) June ZEW Survey Expectations, est. -5.6, prior -2.1
  • 11am: (EC) June ZEW Survey Expectations, prior -1.6

To contact the reporter on this story: Michael Msika in London at mmsika4@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Jon Menon

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