Banks Bet on ‘Ultimate Contrarian Trade’ Amid Brexit Turmoil

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Banks Bet on ‘Ultimate Contrarian Trade’ Amid Brexit Turmoil

With so many unknowns surrounding Britain’s anticipated departure from the European Union (EU), the great majority of investors are leery of purchasing European equities. According to a thorough piece in Bloomberg, Bank of America Merrill Lynch and Morgan Stanley saw huge chances in the region’s badly beaten-down shares, which BofAML calls the “perfect contrarian move.”

“Given the low starting point for both sentiment and relative valuations, we believe even a modest incremental improvement in the European macro backdrop should be helpful for European equities’ relative performance going forward,” said Graham Secker, Morgan Stanley’s chief European equity strategist, in a note cited by Bloomberg. Morgan Stanley’s preferred European stock categories are summarized in the table below.

Morgan Stanley and BofAML’s contrarian approach received a boost Wednesday when British MPs, in an unexpected move, voted against a no-deal Brexit. While there is still significant uncertainty, the decision lessens the likelihood of a disruptive UK withdrawal that would harm the region’s businesses, according to the Wall Street Journal.

European Sectors Morgan Stanley Is Betting On

  • Stocks having cyclical exposure to the United Kingdom and China
  • Stocks in the automotive, transportation, and real estate industries
  • Sectors with significant valuation disparities between high beta and low beta stocks

Source: Morgan Stanley per Bloomberg

Significance For Investors

Morgan Stanley and BofAML aren’t the only ones that are bullish on European equities. “Buying when values are at generational lows is a once-in-a-generation opportunity.” “As special-situations investors, we have observed a substantial increase in the number of firms undergoing strategic transition, providing us with appealing prospective investments,” David Marcus, chief investment officer (CIO) of Evermore Global Advisors, told the news wire.

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Over the last decade, European stocks have trailed significantly behind global indices. According to MSCI, the MSCI All-Country World Index (ACWI) had an average annual return of 10.42% for the ten years ending March 12, 2019, compared to 6.61% for the MSCI Europe Index, which includes only developed nations. Bloomberg estimates that the performance of European equities relative to global markets has been declining since 2002. This is one evidence of the appealing values seen by optimistic thinkers.

“Buying when valuations are at generational lows is the opportunity of a generation.” — David Marcus, Evermore Global Advisors

Rather than seeking for discounts, investors have fled European equities funds. According to statistics from EPFR Global in the article, net withdrawals were roughly $120 billion over the previous 12 months through late February, including about $26 billion since the beginning of 2019.

Investors, according to Wouter Sturkenboom, chief investment strategist for Europe at Northern Trust Asset Management, are “waiting for more clarity on the political front” before investing. However, the issue is becoming more complicated. On Tuesday, the House of Commons decisively rejected Prime Minister Theresa May’s new Brexit proposal. Brexit has already generated significant uncertainty for companies in both the United Kingdom and Europe, and a delay is one conceivable outcome after the vote.

Another source of worry is the European economy’s slowing. “Investors will likely remain on the sidelines until we see the promise of a sustained rebound in growth,” says Tilmann Galler, global market strategist at JPMorgan Asset Management in Frankfurt, according to Bloomberg.

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Looking Ahead

According to another Bloomberg piece, Damien Loh, chief investment officer of Singapore-based hedge fund Ensemble Capital, feels the market is not pricing in the severe repercussions of a “no deal Brexit.” If this occurs, the dangers to Morgan Stanley’s and BofAML’s contrarian approach might skyrocket.

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