French stocks upgraded to overweight

French stocks were upgraded to overweight from underweight by a strategist with HSBC despite the country’s recent government reshuffle and the plunging popularity of President François Hollande.

France sees “upward momentum” in earnings, which is “an intriguing development” considering the low valuation attached to French stocks and “widespread investor pessimism” about the market, Peter Sullivan, equity strategist at HSBC, said in his outlook for European stocks.

He noted that there was a “dramatic reduction” in investor holdings of French stocks over the past two years.

The trend-adjusted price/earnings ratio (which Sullivan’s team calculates by estimating a trend through 20 years of earnings) for French stocks has fallen “to within touching distance of being the lowest on record,” he said.

“Earnings momentum remains negative but it is on an improving trend, suggesting that the worst of the downgrade cycle may be over for France,” Sullivan added.

He is also overweight Spain and Italy, as they both “offer a compelling combination of a low relative valuation and strong earnings momentum.”

Based on price to book value, he estimated that Italy trades on a 24% discount to Europe and Spain on a 23% discount.

Sullivan is underweight UK stocks, where he believes that investor optimism is higher than for any other market.

“Large funds’ holdings are close to the highest we have seen over the eight years that we have data,” he said.

“This leaves the UK vulnerable to disappointment and the short-term momentum drivers (the dynamics) offer little in the way of reassurance.”

He also cut Sweden and the Netherlands to underweight from neutral.

For Sweden, earnings momentum has turned negative but its valuation is the second highest among the stocks analysed by HSBC’s strategists, behind Germany.

For the Netherlands, earnings momentum is the weakest while the 12-month forward p/e ratio is high compared to its historic trend.

@AntoniaOprita