(Telestock) – What to buy in European stocks if the Fed starts cutting interest rates? He asked himself that Bank of America (BofA) in a report on the topic, explaining that it is positioned for lower bond yields, regardless of whether the Fed ends up cutting by choice or necessity, with the recommendation to trade U.S. Treasuries with a bullish bias and the possibility of a bond market rally through the end of the year.
Combined with the expectation of wider risk premia, this leads BofA to underweight cyclicals versus defensivesas defensive stocks tend to outperform on wider risk premiums and lower bond yields. After cyclicals underperformed defensives by 11% from a 30-year high in April, the macro assumption is consistent with another 8% downside ahead.
Among defensive stocks, analysts see thehigher upside for food and drinkwith the sector’s relative price still near a 12-year low and its typical macro sensitivities implying scope for significant outperformance if credit spreads widen and bond yields decline. The macroeconomic case also leaves underweight on financial stocksand European banks in particular, as they typically underperform when bond yields fall and risk premiums rise.
Given the ongoing uncertainties about the macroeconomic outlook, BofA has a series of cyclicals hedges in the portfolio. This list of attractive cyclical hedges includes European semis, luxury goods and chemicals. It does not include autos and airlines, which after strong underperformance would look attractive in a soft-landing growth scenario, but remain vulnerable in the most pessimistic base case.
Finally, analysts expect falling bond yields in response to the Fed’s upcoming easing cycle to boost European growth stocks versus value stockswith projections consistent with growth outperformance of around 10% over the coming months, as well as quality stocks outperformance relative to the market.