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Citi

Europe’s Improving Investment Outlook

  • Domestic policymaking is now tackling the pandemic in a more aggressive and targeted manner, particularly in Germany and France. The cost of the increasing domestic fiscal accommodation is being supported by the European Central Bank (ECB) with continued low rates and its expanded asset purchase program, keeping bond yields low. The potential European breakup risks driven by the periphery are also receding with the EU27 Recovery Fund being agreed. In addition to the substantial size of Euro 750 billion, it demonstrates EU solidarity with Euro 390 billion grants being committed to the periphery.

 

  • Europe also appears to be showing better containment of COVID-19, with much of region seemingly well beyond the peak in cases per million, after the March peak. There are many tough months ahead before a vaccine, with regional surges likely, nevertheless Citi analysts are not expecting another period of prolonged blanket lockdowns.

 

  • Finally, the economic data is improving from the second quarter lows with high frequency data showing a pick-up in broader mobility and economic activity. While the pace of the pickup is likely to ease and Citi analysts do not expect output levels to reach end-2019 levels for at least two years, the trend of gradual improvement seems well underpinned.

 

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  • Equities: The perception change towards European equities is slowly starting to improve, and that could drive inflows. The earnings outlook remains challenging with much dispersion but the next few months should start to see more guidance before a likely average earnings per share rise of over 40% next year. Citi analysts prefer companies with balance sheet strength and cashflows that can support ongoing dividend payouts.

 

  • Bonds: Sovereigns remain expensive and could get more expensive due to ongoing ECB buying. High yield bonds’ average yields have fallen from 10% to 5.7% and could fall further, while defaults are only rising slowly. Downside risk appear low for investment grade bonds, due to support from ECB purchases and rating downgrades are not a widespread risk currently. However, an average yield of only 0.73% means selectivity is necessary.

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