Strategist picks out the sector that still has room for a 10% rally

Published Thu, Aug 12 20211:42 AM EDT

The end is nigh for a 15-month bull run in global stock markets as economic growth moderates, according to Bank of America 's head of European equity strategy, but relative pricing in two sectors is still thought to be "extremely low." Speaking in a CNBC Pro Talks interview on Wednesday, BofA's Sebastian Raedler explained that with no further upside expected for European stocks over the coming months, his team had lowered its exposure to cyclical stocks and increased its allocation to defensives. Cyclicals are stocks whose performance tends to align with the trajectory of the global economy, while defensives generally provide stable earnings and dividends irrespective of the economic cycle. However, the Wall Street bank highlighted two major exceptions to the cyclical sell based on their current value: banks and airlines. Both sectors have thus far managed to avoid share prices catching up with the optimism that has driven stock markets to historic highs. Banks Bank of America believes that in the near term, bond yields have the potential to rise, since the market is underpricing the potential for the U.S. Federal Reserve to tighten its historically loose monetary policy sooner than expected. U.S. Treasury yields have pulled back sharply in recent months, disconnecting from their usual relationship with growth momentum, Raedler said. He argued that the combination of higher bond yields and lingering growth momentum for the next few months, before the growth slowdown begins in earnest in the fourth quarter, makes banks one of the "last cyclical catch-up plays that still look attractive." "Banks typically like two things: they like higher rates and they like accelerating growth. So in the near-term, we think that banks have not yet fully caught up with the strong growth momentum that we have in Europe. If bond yields rise, they should be supported by higher bond yields as well," Raedler said. "So in the near term, we still see scope for banks to outperform by around 10% as bond yields rise and growth momentum remains strong, but then once the real slowdown starts, towards the end of the year and going into next year, then we have to acknowledge that financials are very sensitive to the economic cycle." Airlines Bank of America also holds an "overweight" position in airlines , which have been beaten up over the past 18 months as the Covid-19 pandemic brought global travel to a near standstill. Although slowing economic growth would ordinarily affect cyclical stocks like airlines, Raedler said investors need to look not just at the economic cycle, but what is priced into current stock valuations. "Amazingly, the price relative to the market is back to the pandemic lows that we saw in March last year," he said. "If you looked at the airline pricing, you would think that we are still in the depths of a pandemic, there are no vaccines, there is n