Christopher Street Capital says a correction in European equities may benearing an end after a 3.6 percent fall since their Apr. 2 peak eroded theiroutperformance over the corporate credit market, with which stocks tend to becorrelated.
The iTraxx Europe, an index tracking credit default swaps (CDS) on Europeancorporate credit, is at its most bullish since November versus the STOXX 50 equity index, according to iTraxx credit-to-equity indicators (C2E).
A CDS insures the holder against the default of an entity and the contract'sprice rises if the entity's financial situation worsens.
"On the face of things the C2E relationship looks healthier now than it hasin a while," Christopher Street Capital's analysts write in a note.
"Both implied upside and C2E divergence are as positive as we have seensince November 2012 - the start of the turn of the year rally, suggesting thatmaybe this correction has gone far enough for now."
The analysts caution the STOXX50 still looks unattractively valued, tradingin the most expensive third of its risk-adjusted historical range at 13.3 timesits expected earnings for the next 12 months, compared with the U.S. S&P 500 and Japan's Nikkei 225, both in the cheapest 10 percent.
In addition, an underperformance of cyclical and financial stocks andlacklustre economic data are not conducive for a cyclical rally, the analystssay.
In this context, they recommend "long" positions in stocks with low CDSspreads and high dividend yields, such as tobacco maker Imperial Tobacco, Royal Dutch Shell and "short" positions in shares with lowspreads and low dividend, such as British credit information firm Experian and beverage group Diageo.
Short sellers borrow securities with a view to selling them, betting theywill be able to buy them back at a lower price before returning them to thelender.
Reuters messaging rm://francesco.canepa.thomsonreuters.com@reuters.net
Experian (EXPN)
Diageo (DGE)
