Investing.com -- Bank of America (NYSE:BAC) (BofA) sees a correction looming for European equities, warning that markets are overly optimistic about the region’s ability to withstand a global slowdown.
The bank’s strategists expect a “10%+ downside for European equities by mid-year as the growth acceleration the market is priced for fails to materialize.”
While global growth concerns are mounting, investors remain bullish on European equities, assuming the region will be insulated from external pressures. BofA disputes that view.
“We are doubtful that either European macro momentum or European asset prices will remain immune once that growth weakness starts to show up in the data,” the bank said.
The euro area’s open economy makes it particularly vulnerable to global weakness. According to BofA, every one-point drop in the global ex-euro area PMI could subtract 0.6 points from euro area PMI. Meanwhile, a delayed impact from Germany’s fiscal package and looming trade tensions with the U.S. add further downside risks.
Despite recent gains, BofA notes that European equities are still priced for a global acceleration, not a downturn. The Stoxx 600 index remains close to all-time highs, and cyclical stocks have been pricing in tightening risk premia and higher bond yields.
“These relationships have nonetheless remained impressively robust over recent years, leading us to doubt that, in case of more pronounced global macro weakness, the recent decoupling can be sustained,” the strategists continued.
BofA has lowered its stance on Europe from Overweight to Market Weight and remains Underweight European cyclicals relative to defensives.
Financials and Industrials are seen as most at risk, while Chemicals and Semiconductors are viewed as more resilient within cyclicals. Among defensives, Staples and Utilities are expected to outperform if global growth continues to weaken.
However, the firm remains Overweight in European small caps versus large caps “as they have lagged the positive news around Euro area growth momentum and are relatively protected from global trade uncertainty.”
The bank projects the STOXX 600 could drop to 470 by mid-year, before potentially recovering to 500 by year-end.