Looming Downturn Lifts Europe’s Chip And Luxury Shares

By Henry Ren and Michael Msika, Bloomberg Markets live reporters and analysts

With credit conditions steadily tightening, equity traders are switching back to the “bad news is bad news” narrative as they brace for a recession. So how to position for it? Europe’s tech and luxury sectors — less sensitive to economic downturns given their secular trends — seem like a good place to start.

Tech has flipped from being last year’s laggard to be one of Europe’s market leaders in 2023. The Stoxx 600 Tech Index is up 19% year-to-date, with chip shares such as ASM International and STMicroelectronics up more than 40%. Meanwhile, an MSCI index of luxury shares has rallied 24% this year, with China’s post-Covid reopening helping companies such LVMH and Hermes scale record highs.

Luxury and tech are both classed as growth sectors, benefiting when bond yields slide and central banks ease off the policy-tightening pedal. Tech is particularly sensitive to peak-rate expectations, given companies’ future earnings hinge on low borrowing costs. And both sectors received an extra boost from recent financial turmoil, which pushed investors to seek shares in companies perceived to have robust balance sheets and promising business models. The below chart shows the lockstep moves between bond yields and tech shares.

Citigroup strategists upgraded European tech stocks to overweight on March 23, citing their preference for quality growth. The firm’s analysts agreed. “Our base case view at the start of the year was for the sector outperformance to resume and we reiterate the same,” Citi’s Amit Harchandani told clients last week. Goldman Sachs strategists concur, also  upgrading the sector to overweight and predicting a further 25% share price upside.

A look at Europe’s top tech stocks shows each has a fundamental story to tell. ASML for instance expects a 25% revenue increase this year, SAP’s sale of its Qualtrics cloud business is seen boosting profit, while Prosus is benefiting from its stake in China’s Tencent. Infineon is enjoying robust chip demand from the car industry.

All that has already boosted the sector’s earnings forecasts by 3.9% this year, beating the Stoxx 600’s 1.1% rise and the Nasdaq 100’s 0.7% upgrade. Infineon, which just raised revenue forecasts, enjoyed a larger lift to estimates, as did its peer STMicro. As a result of this, the Stoxx Tech Index trades around 23.8 times forward earnings — at about its five-year average. The Nasdaq 100 on the other hand, carries a 5% premium to five-year multiples.

Still, not all tech is favored. Companies reliant on discretionary consumer spending, such as keyboard maker Logitech and video-game producer Ubisoft, are underperforming. Tech names with high debt or low profitability — Sinch, Ams-OSRAM and Just Eat Takeaway feature here — also remain in the cold.

The sector may also struggle to sustain its rally if things worsen. Morgan Stanley’s Michael Wilson, for instance, considers tech to be a cyclical-oriented sector, and says health-care and utilities will offer better protection during downturns. Another risk is that peak interest rates are further than expected and central banks double down on rate hikes. A subsequent bond selloff could well crush tech, as was the case in 2022.

“Tech will certainly be vulnerable to moves in the bond market in the short term,” Marcus Morris-Eyton, a portfolio manager at Allianz Global Investors, said. However, he expects companies with clear technology leadership to outperform, especially as they have “none of the balance sheet questions that investors are currently debating in other sectors.”