In what some may find an amusing change in outlook by the bank that less than a year ago was on insolvency's door, its stock at record lows, this morning Deutsche Bank downgraded its peers, other (ostensibly more sound) European banks, to underweight from benchmark on expectations that fading euro-area growth momentum will weigh on the sector over coming months.
At the same time, DB strategist Andreas Bruckner also Upgraded energy to overweight from underweight as recent USD weakness points to near-term upside for oil. He also upgraded construction materials to overweight from underweight as the recent correction has gone too far given sector is already priced for severe slowdown in global growth and a sharp rise in U.S. credit spreads even as they have tightened.
The German bank also downgrades tech to benchmark from overweight given fair price after outperformance and USD weakness, DB notes however that within tech, Deutsche Bank prefers semiconductors.
It also downgraded airlines to benchmark from overweight, and downgrades consumer durables to underweight from benchmark on expected slowdown in global PMI momentum, fading U.S. consumer confidence and high valuation. Finally, it reduced its underweight in mining as sector is below fair value estimate.
Banks – downgrade from benchmark to underweight, as fading Euro area growth momentum is set to weigh on the sector over the coming months. The Euro area composite PMI new orders index, at 55.5, is consistent with 3% Euro area GDP growth, significantly above our economists’ GDP forecast of 1.8%. If PMIs fade back to the levels consistent with our economists’ projections (at around 53), this would imply PMI momentum (i.e. the six-month change in PMIs) turning negative over the coming months.
Banks are among the sectors most sensitive to swings in Euro area PMI momentum and tend to underperform when it turns negative. There is no particular valuation support, with the sector’s P/E discount at 20%, roughly in line with the long-term average. We expect PMI momentum to trough later in the year, at which point we will be looking to turn more positive on banks, especially given that our sector analysts see upside for the sector over the next 12 months (as a function of the expected interest rate normalization).
Energy – upgrade from underweight to overweight: the sector has underperformed the market by 12% year-to-date, making it the worst performing sector so far this year. Following the recent correction, energy is around 5% cheap on our short-term fair-value model based on oil and sterling (the largest upside in four years). It also ranks as the cheapest sector on our European sector valuation scorecard. The relationship between the oil price and the USD points to near-term upside for oil, given the recent USD weakness. Lastly, oil speculative positions have fallen sharply from asix-year peak in February, pointing to a more balanced market sentiment. The key risks for the sector are the continued rebound in US shale oil production and the scope for renewed USD strength weighing on commodity prices (though we note that our FX strategists have recently reduced their projected USD upside for the rest of the year).
Construction materials – upgrade from underweight to overweight: the sector has underperformed the market by around 9% since early December, making it the third worst performing sector over that period (after energy and food retail). The correction now seems to have gone too far, given that: (a) the sector is already priced for a slowdown in global growth momentum that is significantly harsher than the mild fade that we envisage; (b) it is discounting a sharp rise in US credit spreads, even as the actual spreads have continued to tighten; (c) the sector would benefit from a further fall in the European policy uncertainty index from still-elevated levels; and (d) the sector’s P/E relative is close to the lowest level since 2009.
Tech – downgrade from overweight to benchmark, given that: (a) the sector has outperformed the market by around 12% since early December and appears fairly-priced on our two-factor model; (b) the case for dollar strength, which has historically been a key performance driver due to the sector’s above-average sales exposure to the US, has softened and tech has yet not caught up with the recent USD weakness; and (c) the sector ranks as the most expensive sector on our European sector valuation scorecard. Within tech, we prefer semiconductors (~30% of tech market cap) which has not yet caught up with the recent rebound in US consumer confidence.
Airlines – downgrade from overweight to benchmark: the sector has outperformed the market by almost 25% since the beginning of the year, supported by lower commodity prices and favorable FX moves. As such, it has now overshot its underlying drivers and is more than 10% above fair value according to our 3-factor model (based on oil prices, Sterling and peripheral bond spreads). On the upside, the sector could benefit from a further reduction in European policy uncertainty – and relative P/Es remain close to a 10-year low (at a 35% discount to the market).
Consumer durables (i.e. luxury goods) – downgrade from benchmark to underweight, given that (a) the sector is highly sensitive to swings in global growth, but has not yet reacted to the recent fade in global PMI momentum, which we think has further to go; (b) the sector has outperformed in line with the post-election rebound in US consumer confidence to a 17-year high, but this has recently started to fade, and (c) the sector’s relative P/E, at a 30% premium to the market, is almost one standard deviation above its long-run average.
Mining – reduce underweight: the sector has been the weakest sector in Europe over the past three months, underperforming the market by around 15% on the back of falling metal prices. As a consequence, our fair-value model (based on copper, sterling and US real rates) now points to around 5% upside. Yet, we remain underweight, given that: (a) after its recent sharp fall, the iron ore price points to around 40% downside for miners’ relative EPS, suggesting renewed earnings downgrades to come; (b) adjusting for the iron-ore implied EPS downside, the relative P/E is around one standard deviation above the long-term average; (c) we expect the China credit impulse to turn negative again over the coming months, which would be consistent with further downside for iron ore; (d) global PMI momentum has started to roll over – and mining tends to underperform when this is the case.
Finally, this is why DB is increasingly souring on the European recovery: the bank believes the Euro area PMI momentum is set to turn negative over the coming months, and explains why in the charts below.
And now we wait for other European banks to downgrade Deutsche Bank in sympathy.