Unloved Corner of Market Loses $68 Billion: Taking Stock

(Bloomberg) --

It hasn’t been a great month for European stocks, but one segment of the market that investors love to hate has been particularly scorned.

Small-cap stocks, which are known for doing well during powerful rallies, quickly succumbed to the market malaise in May and underperformed larger peers, losing as much as $68 billion in market value. SocGen didn’t hesitate to downgrade euro-zone small caps to underweight last week, as strategists expect investors to be disappointed by slower earnings growth after profits more than halved over the past year.

Liquidity is another factor speaking loudly against smaller European companies. Since such stocks usually have fewer asset managers holding them, they tend to be the most vulnerable to economic slowdown, and this is especially true for Europe, which is one of the world’s most popular short trades.

“Aside from their greater, typical natural link to the local or regional economy, small caps are easily ignored by global investors because the big at-the-margin money (American, typically) regard them as micro caps,” says Chris Bailey, a European strategist at Raymond James in London. “Liquidity is already poor in European stocks and hence unless there’s a return to a much more euphoric view towards European stocks, small caps are going to lag. However, when they do bounce, they will bounce hard."

Until this month’s gloom chased investors away, things were going very well for smaller European firms. The Stoxx Europe Small 200 Index was up 17% on the year through the end of April, beating the benchmark and the 16% advance in the Stoxx Europe Large 200 Index. In May, as global money managers reduced their stock holdings amid trade tensions and political (think Brexit, Italy) concerns, large caps have done considerably better.

“While the market has strongly rebounded since the beginning of the year, small caps have failed to catch up,” write SocGen strategists including Kevin Redureau. “We expect EPS to remain flat in Europe this year, so given higher expectations, small caps are more at risk from downgrades than large caps in our view."

At the same time, this month’s sell-off has narrowed the valuation gap between European small and large companies and the Stoxx Europe Small 200 Index now trades at the lowest premium over the Stoxx Europe Large 200 counterpart in 16 months. This could lure some buyers despite the general pessimism about smaller stocks.

Jeff Meyers, founder and chief investment officer of Cobia Capital in New York, used this month’s dip to pick some European small caps, including ESI Group, a French software developer, and XLMedia Plc, a digital marketing services provider listed in London.

“There’s still plenty of idiosyncratic opportunities out there, we look for cheap companies but with a growth catalyst, we like companies that are turning the corner and are ready to grow pretty quickly,” Meyers says. “If you buy the index, you’re going to get hit by the downturn, but if you’re a stock picker, downturns definitely present abundant opportunities to buy undervalued companies that are profitable and growing.”

SocGen strategists don’t hate all European small caps and while they stay away from smaller U.K. firms because of Brexit risks, they favor French and German small caps because of their attractive valuations. Also, among smaller stocks, it’s best to stick with growth shares rather than cheaper value ones because companies displaying stronger profit growth are more defensive, said the analysts.

Finally, a bright spot on the European small-cap horizon, according to SocGen, is that leverage ratios have recently improved thanks to stronger profitability, which can’t be said of their U.S. peers.

Ahead of the open this morning, Euro Stoxx 50 futures are down 0.7%, mirroring a late sell-off on Wall Street on Tuesday.

SECTORS IN FOCUS TODAY:

• Watch shares in European catering companies including Sodexo and Compass, after peer Elior forecast FY 2018-2019 organic revenue growth of -1% compared with a previous forecast of more than 1%.
• Watch dollar-sensitive stocks. The Bloomberg Dollar Spot Index is on course to post a fourth straight monthly advance, its longest winning streak since 2015. The euro trades at $1.1166 this morning.
• Watch banks as bond yields continue to fall. U.S.-China trade tensions and faltering global growth have seen U.S. 10-year yields tumble almost 40 basis points since mid-April to as low as 2.24% on Wednesday.

COMMENT:

• “Despite the U.K. and European bourses having a low exposure to technology, the flattening of the yield curves has hurt the banks while dissuading investors from owning the cheap, more cyclical parts of the equity market such as energy and materials,” Jefferies strategists write in a note. “The remorseless liquidation of U.K. and European equities seems to have coincided with relentless earnings downgrades. However, equity risk premium is near two decade highs for most bourses.”

COMPANY NEWS AND M&A:

• Mediaset Agrees to Buy 9.6% in Germany’s ProSiebenSat.1
• Elior Cuts 2018-2019 Revenue Organic Growth Guidance
• Casino Group Decided Not to Pay Interim Dividend in 2019
• Nissan Says Tentatively Not Against Renault-Fiat Merger: Nikkei
• Elekta Fourth-Quarter Operating Profit 4.0% Above Estimates
• Tele Columbus 1Q Revenue EU120.1m; Confirms FY 2019 Guidance
• Aroundtown Firs- Quarter Adjusted Ebitda EU179.6 Mln
• Genmab Files for U.S. IPO of American Depositary Shares
• Rocket Internet 1Q Ebitda Loss EU14 Mln Vs. Loss EU24.0 Mln Y/y
• Carrefour Brasil, Magazine Luiza Rise on ‘Assertive’ Partnership
• EDF May Keep 65%-70% of Power Distribution, Renewables: AFP
• Wirecard Says Goldman’s Total Voting Rights 3.53% as of May 20
• Aveva Full-Year Adjusted EPS 90.90p
• Pathe in Talks With EuropaCorp to Buy Majority Stake: Les Echos

NOTES FROM THE SELL SIDE:

• Duerr is returned to a buy rating, with the stock’s recent slump making valuation attractive again and pessimism about FY19 earnings now appearing unjustified, Baader Helvea says in note.
• Beiersdorf’s acquisition of Coppertone suggests that its new CEO will make more use of the co.’s balance sheet, Bankhaus Lampe says, upgrading to buy from hold.
• Russia screens best and provides the biggest opportunities within Morgan Stanley’s EEMEA banks coverage, the broker says, upgrading Sberbank to overweight and VTB to equal-weight, while Samba is cut to underweight.

TECHNICAL OUTLOOK for Stoxx 600 index:

• Resistance at 383.3 (50-DMA); 385.7 (76.4% Fibo)
• Support at 374.5 (61.8% Fibo); 368.8 (200-DMA)
• RSI: 42

TECHNICAL OUTLOOK for Euro Stoxx 50 index:

• Resistance at 3,403 (61.8% Fibo); 3,412 (50-DMA)
• Support at 3,309 (50% Fibo); 3,270 (200-DMA)
• RSI: 42.7

MAIN RESEARCH AND RATING CHANGES:
UPGRADES:

• Accor upgraded to neutral at MainFirst; PT 36 Euros
• BN FP raised to buy at LBBW
• Beiersdorf upgraded to buy at Bankhaus Lampe
• EDP Renovaveis upgraded to outperform at BBVA; PT 10 Euros
• Lundbergforetagen upgraded to buy at DNB Markets; PT 360 Kronor
• REN upgraded to market perform at BBVA; PT 2.40 Euros
• Serco upgraded to outperform at RBC; PT 1.50 Pounds
• Telefonica Deutschland raised to neutral at Macquarie
• VTB GDRs upgraded to equal-weight at Morgan Stanley; PT $1.55

DOWNGRADES:

• Bechtle cut to hold at Baader Helvea; Price Target 112 Euros
• Ocean Yield downgraded to hold at Kepler Cheuvreux; PT 62 Kroner

INITIATIONS:

• DFCH rated new outperform at Macquarie
• Diploma rated new overweight at JPMorgan; PT 16.78 Pounds
• Electrocomponents rated new neutral at JPMorgan; PT 5.91 Pounds
• Network International rated new buy at Liberum; PT 6.50 Pounds
• Sunrise rated new outperform at MainFirst; PT 80 Francs
• Swisscom rated new underperform at MainFirst; PT 450 Francs
• Ultra Electronics rated new hold at Jefferies; PT 17.75 Pounds
• Valmet rated new hold at SEB Equities; PT 24 Euros

MARKETS:

• MSCI Asia Pacific down 0.5%, Nikkei 225 down 1.2%
• S&P 500 down 0.8%, Dow down 0.9%, Nasdaq down 0.4%
• Euro up 0.06% at $1.1167
• Dollar Index down 0.05% at 97.9
• Yen up 0.07% at 109.3
• Brent down 0.7% at $69.6/bbl, WTI down 1% to $58.6/bbl
• LME 3m Copper down 0.3% at $5944/MT
• Gold spot up 0.1% at $1280.9/oz
• US 10Yr yield down 3bps at 2.24%

MAIN MACRO DATA (all times CET):

• 8:45am: (FR) April PPI YoY, prior 1.9%
• 8:45am: (FR) April PPI MoM, prior 0.0%
• 8:45am: (FR) April Consumer Spending YoY, est. 0.6%, prior -1.9%
• 8:45am: (FR) May CPI EU Harmonized MoM, est. 0.3%, prior 0.4%
• 8:45am: (FR) May CPI EU Harmonized YoY, est. 1.2%, prior 1.5%
• 8:45am: (FR) May CPI MoM, est. 0.3%, prior 0.3%
• 8:45am: (FR) May CPI YoY, est. 1.1%, prior 1.3%
• 8:45am: (FR) 1Q F GDP QoQ, est. 0.3%, prior 0.3%
• 8:45am: (FR) 1Q F GDP YoY, est. 1.1%, prior 1.1%
• 8:45am: (FR) April Consumer Spending MoM, est. 0.4%, prior -0.1%
• 9:55am: (GE) May Unemployment Change (000’s), est. -8,000, prior -12,000
• 9:55am: (GE) May Unemployment Claims Rate SA, est. 4.9%, prior 4.9%
• 10am: (IT) May Consumer Confidence Index, est. 110, prior 110.5
• 10am: (IT) May Manufacturing Confidence, est. 100.4, prior 100.6
• 10am: (IT) May Economic Sentiment, prior 98.7

To contact the reporter on this story: Ksenia Galouchko in London at kgalouchko1@bloomberg.net

To contact the editors responsible for this story: Celeste Perri at cperri@bloomberg.net, Blaise Robinson

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