When it comes to European stocks, Deutsche Bank has made up its mind: sell in May and don't come back at all this year.
In a note released overnight by DB's Sebastian Raelder titled "No further upside for 2016: we downgrade our year-end Stoxx 600 target to 325" from 380 and currently at 338, cited by some as the reason for today's sudden reversal in European equities, the strategist turned very bearish on Europe, citing the latest FOMC minutes as a reason for increasing risks with fears that the market will re-enter the "doom loop" from a more hawkish Fed to a stronger dollar, lower oil prices, higher HY credit spreads and lower equity markets.
On the upside, they think the Fed’s increased sensitivity to the problem of dollar strength means it will quickly abandon its tightening intentions once asset prices are falling, thus capping the downside for markets.
The dynamic is familiar to everyone by now, and was made explicit in a note last week by BofA laying out the "Nightmarish Merry-Go-Round" for the Fed, which is forced to turn dovish every time it hints at tightening:
Here is the full argument from Germany's largest, and according to some most impacted shoudl the "doom loop" truly return, bank:
We see no further upside for European equities for the rest of this year.
In January, we projected that the Fed rate hike would lead to increased financial stress and falling equity markets; this, we argued, would lead the Fed to turn more dovish, which – in turn – would allow equities to rebound. This has played out. Yet, the Fed relent has been partial – and the latest FOMC minutes point to increasing risks that we will re-enter the “doom loop” from a more hawkish Fed to a stronger dollar, lower oil prices, higher HY credit spreads and lower equity markets.
On the upside, we think the Fed’s increased sensitivity to the problem of dollar strength means it will quickly abandon its tightening intentions once asset prices are falling, thus capping the downside for markets. Overall, though, the combination of weak global growth, Fed risk, a likely fade in China’s growth rebound and fragilities in the US high-yield credit market significantly undermines the upside case for European equities from current levels. As a consequence, we reduce our end-2016 Stoxx 600 target from 380 to 325, 4% below current levels. We introduce our end-2017 target of 345. We project 2016 EPS growth of minus 2% (down from our previous projection of 4.5% and compared to consensus at 0.5%), implying EPS of €21.3.
Scenario analysis. We project our index target using a probability-weighted scenario analysis:
Muddle-through scenario (50% probability): Either no Fed rate hike – or a quick dovish turn by the Fed after one additional hike to limit the market fall-out. Chinese and global growth only slow moderately, commodity prices hold up and credit spreads remain well-behaved. In this scenario our models project a fair-value level of ~350 for the Stoxx 600.
Downside scenario (35% probability): We re-enter the “doom loop”, against the backdrop of a sharper-than-expected slowdown in China. Commodity prices drop and credit spreads widen. Our models project ~270 for the Stoxx 600.
Upside scenario (15% probability): The Fed does not hike despite accelerating global growth, driven by more easing in China and the delayed positive impact from lower oil on DM consumption. Stronger growth, easier financial conditions and declining macro uncertainty (due to a pro-EU vote in the UK referendum) boost asset prices. The fair-value level for the Stoxx 600 rises to ~375.
DB then goes on to lay out the main risks, about which it says that it sees four main negative catalysts for European equities over the coming months:
- Global macro momentum is likely to remain weak: US growth is set to remain mediocre (given weak productivity growth and an inventory overhang), while China’s growth rebound is set to fade (as the impact of Q1’s aggressive credit stimulus dissipates). EM is encumbered by high private-sector debt, the risk from a hawkish Fed (leading to more capital outflows) and weaker commodity prices (due to a stronger dollar and weaker Chinese growth), while the prospect for European growth remains unexciting;
- The Fed will likely try to hike at least once this year unless asset prices fall or macro momentum slows sharply (none of which would be good for European equities). Any Fed hiking attempt is set to put renewed downside pressure on the RMB (as short-term yield differentials move against the Chinese currency) – as well as adding to dollar strength, which is set to push down oil prices and push up US HY credit spreads, hurting risk sentiment more broadly;
- We see upside risks for US high-yield spreads: these are priced for default rates to decline to ~3.5% by year-end, even as realized default rates keep rising (they hit 4.4% in April), lead indicators point to further upside for defaults and our strategists sees a two-in-three chance of a turn in the credit cycle of the coming months. Every 100bps rise in HY credit spreads is associated with a 4.5% drop in the fair-value level of European equities, according to our model;
- Valuations and sentiment are not particularly supportive: our P/E model points to 2% downside, while our ERP model suggests fair value is 7% below current levels. Investor sentiment is at neutral levels, according to our indicators.
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To summarize, here is a list of bank that have turned decidedly gloomish on risk assets in the past few weeks: Goldman, JPM, Citi, DB, Bank of America, and now Deutsche Bank.