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BlackRock has closed its "underweight" position in European equities and credit, and upgraded European government bonds to "overweight," in anticipation of a "decisively dovish" shift in policy from the European Central Bank (ECB).
Analysts with the world's largest asset manager anticipate that Thursday's monetary policy meeting will lay the foundations for the ECB to deploy a fresh stimulus package in the coming months, against a backdrop of a "stabilizing growth outlook and persistent inflation undershoots."
In a note published Tuesday, BlackRock's financial conditions indicator (FCI) highlighted a slow recovery in euro zone economic conditions since the debt crisis in 2011, and projected that stubbornly low inflation would twist the arm of the central bank into providing more stimulus in the coming months.
"The package we expect is not yet fully reflected in markets, in our view, and should help further ease financial conditions and support European assets," BlackRock analysts suggested.
"The ECB may outline its thinking at this week's policy meeting and take action later in the year. Measures could include further cuts to its already negative 0.4% deposit rate and a new round of purchases of financial assets including corporate bonds," the note added.
BlackRock has recently downgraded its global growth outlook on the back of macro uncertainty stoked by trade and geopolitical tensions. The growth outlook weakened primarily in the U.S. and China, the two combatants in a drawn out trade war, but steadied at below-trend levels in the euro zone.
Analysts predicted that the dovish shift from central banks will likely facilitate a "relatively benign environment" for risk assets in the short term. China's growth is expected to stabilize, with gross domestic product (GDP) having grown 6.2% year-on-year in the second quarter, while policymakers stand ready to deploy fiscal stimulus and thus ease concerns about a knock-on effect to the European economy.
"In government debt, we expect peripherals, or government bonds of mostly southern-tier countries, to benefit most from the fresh stimulus," the analysts said.
"A 'lower for longer' environment should support credit as a source of income in a region where many government bond yields of core countries are negative."
With earnings expectations seen to have largely priced in risks of slower growth, BlackRock has identified potential for an earnings rebound next year, seeing the current expected return advantage of holding European equities over government bonds as similar to that of riskier emerging markets.
"We prefer the quality factor and defensive sectors that feature high profitability, stable earnings and low indebtedness, such as pharmaceuticals," the note explained.
"We like companies with sustainable and relatively high dividend yields. These stocks, as well as European high-yield credit and peripherals, are particularly attractive for hedged U.S. dollar-based investors."
The note expressed caution over the consumer discretionary sector due to its vulnerability to trade conflicts, however, and advocated avoiding banks given negative rates.