Global Equity Strategist --Euro Crisis, Global Contagion :: Citi Research

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Global Equity Strategist
Euro Crisis, Global Contagion
 Sovereign Crisis, Banking Crisis, Recession — Our economists believe the
sovereign and banking crisis in the Euro Zone will lead to a protracted recession.
With the help of CIRA economists, strategists and sector analysts we consider what
a Euro Crisis will mean for equity markets around the world.
 Euro Recession, Global Consequences — CIRA economists forecast Euro Zone
real GDP to contract for 6 consecutive quarters and not get back to previous peak
levels for many years to come. Non-European companies with significant revenue
exposure to the region include Johnson Controls, Paccar, Nikon, HTC and
Cochlear.
 Bank Deleveraging — CIRA analysts show that Continental European Banks are
amongst the most leveraged in the world. Further deleveraging may weigh on credit
growth in Central and Eastern Europe which is most reliant on Euro Bank financing.
 Global Opportunities — The Euro Crisis also brings global opportunities. CIRA
Banks analysts believe US and UK Financials may win market share from their Euro
peers. CIRA equity strategists expect Euro exporters and Emerging Market equities
will outperform as they benefit from a weaker currency and easier policy.
Market Outlook
We remain constructive on global equity markets and expect 20%+ gains by
end of 2012. We think the stock market is questioning the sustainability of
current corporate earnings and pricing a global EPS contraction of around 10%
for 2012. This is unlikely to happen, in our view. We expect EPS growth to
slow, but not reverse in 2012, in parallel with our economists’ GDP forecasts.
Our forecasts for global EPS growth are 2% in 2012. Our MSCI ACWI 2012
year-end target is 360 (currently 304). As equities have de-rated sharply,
cheap valuations should provide a buffer against further bad macro news.
Regional Strategy
Our key regional and global sector recommendations are summarised in Figure 15.
Emerging Markets remain our preferred structural growth play. EM economies offer
premium GDP growth, which should translate into premium EPS growth. We stay
Overweight. We are also Overweight Japan, which is our recovery play. The postearthquake
EPS downgrades have reversed and we believe Japan can benefit from
positive earnings trends from this point. We favor EM plays in the developed world.
We are Overweight UK due to its heavy weighting of commodity companies. We
remain neutral on Europe ex UK. The region is the epicenter of current concerns.
However, valuations look very cheap. We suspect the region will enjoy considerable
outperformance if authorities take credible steps to address sovereign concerns. We
lowered the US to Underweight as it is expensive relative to other equity markets
where we see better opportunities. We remain underweight Australia as we think UK
is a cheaper place to play the “EM in DM” theme.
Sector Strategy
Our global sector strategy also has an Emerging Market tilt. We are Overweight
sectors with some of the largest EM end market exposure such as Materials, IT and
Consumer Staples. These sectors have solid earnings and reasonable valuations.
Despite dismal earnings momentum, we keep Financials at Neutral as we think
short-term performance may be strong if there is an improvement in investors’ risk
appetites. Our Underweight sectors include a mix of global cyclicals and defensives.
We are Underweight Industrials and Consumer Discretionary as earnings
momentum is moderating for these sectors. We are also Underweight Utilities as we
believe unique headwinds for the sector will persist for some time to come.
Risk
The main risks to our outlook stem from Europe and potential secondary
consequences for global growth.