Small is decidedly not beautiful for European equities, according to Societe Generale (SocGen) SA.
Investors should short the Euro Stoxx Small Index while going long on the blue-chip Euro Stoxx 50 Index, given the prospect of greater “liquidity-driven shocks” ahead for markets, SocGen strategists said. European equity funds have registered almost nonstop outflows this year, a trend that isn’t likely to change soon, they said.
Despite strong balance-sheet fundamentals, profitability and valuations, strategists led by Roland Kaloyan expressed concern about liquidity as the economy slows. “The fact that small caps failed to outperform large caps at the beginning of the year, in a bullish market driven by central bank easing, sends a clear signal that the market is now favouring liquid investments,” they wrote in a note.
The Euro Stoxx 50 is trading at its highest level relative to the small-cap gauge in almost a year, widening the gap in recent weeks.
Shares of smaller companies, which rallied thrice as much as their blue-chip peers in 2017, have struggled to keep up since. SocGen is underweight on these relative to large caps, both in the euro area and the UK.
Adding to liquidity issues, small caps are beginning to face lower margins, and profitability isn’t likely to improve at this point in the cycle amid Europe’s economic slowdown, the strategists said.