HSBC warns investors to avoid European stocks in the search for value

Investors should avoid allocating to Europe in the hunt for value stocks, as the continent’s energy crisis means the risk-reward is still not there, according to Willem Sels, global CIO at HSBC Private Banking and Wealth Management.

The macroeconomic outlook in Europe is bleak as supply disruptions and the impact of Russia’s war in Ukraine on energy and food prices continue to stifle growth, and force central banks to tighten monetary policy aggressively to rein in inflation.

Typically, investors have turned to European markets in search of value stocks — companies that trade at a low price relative to their financial fundamentals — when trying to weather volatility by investing in stocks offering stable longer-term income.

By contrast, the U.S. offers an abundance of big name growth stocks — companies expected to grow earnings at a faster rate than the industry average.

Although Europe is a cheaper market than the U.S., Sels suggested that the differential between the two in terms of price-to-earnings ratios — companies’ valuations based on their current share price relative to their per-share earnings — does not “compensate for the additional risk that you’re taking.”

“We think that the emphasis should be on quality. If you’re looking for a style bias and are going to make the decision on the basis of style, I think you should look at the quality differential between Europe and the U.S., rather than the growth versus value one,” Sels told CNBC last week.

“I actually don’t think that clients and investors should be looking at making the geographical allocation on the basis of style — I think they should be doing it on the basis of what is your economic and your earnings outlook, so I would caution against buying Europe because of the cheaper valuations and interest rate movements.”

With earnings season set to kick off in earnest next month, analysts broadly expect earnings downgrades to dominate worldwide in the short term. Central banks remain committed to raising interest rates to tackle inflation while acknowledging that this may induce economic strife, and possibly recession.

“We see an economic slowdown, higher-for-longer inflationary pressures, and greater public and private spending to address the short-term consequences and long-term causes of the energy crisis,” said Nigel Bolton, Co-CIO at BlackRock Fundamental Equities.

However, in a fourth-quarter outlook report published Wednesday, Bolton suggested that stock pickers can seek to capitalize on valuation divergences across companies and regions, but will have to identify businesses that will help provide solutions to rising prices and rates.

He argued, for example, that…