With the global credit cycle weakening, the risk-return trade-off for equities is worsening too, cautions BCA Research.
In a research note, BCA observes that the credit impulses in the world’s three major economies – the euro area, the United States and China – are now negative. “This is the first time in three years that all three components have been simultaneously negative. And after hovering at a point of inflection the combined credit cycle indicator has lurched down again,” it observes.
BCA notes that, for any open exporting economy, such as the euro area, the global credit cycle is much more important than the domestic credit cycle, as the sales and profits of large European companies are sourced globally.
“A weakening credit cycle normally precedes a poorer return/risk trade-off for risk assets such as equities – through lower returns and/or higher volatility,” it says. As a result, BCA says that, after recent strong rallies, European equities seem vulnerable to any new downgrades to growth, and it warns against an absolute overweight position in European equities.