Investinf.com -- Analysts at HSBC in a note dated Wednesday have revised their sector ratings within the UK, reflecting a more cautious stance as the macroeconomic landscape remains uncertain.
The analysts flagged a shift towards defensive sectors due to weakening earnings prospects and concerns over deteriorating economic growth.
The UK market, particularly the domestically focused FTSE 250, has outperformed other European indices in the third quarter of 2024, a surprising development given the broader economic challenges.
While falling interest rates and a political renewal following the Labour Party's landslide election victory have buoyed investor sentiment, the backdrop is still fraught with risks.
GDP growth has stagnated, business and consumer confidence has sharply declined according to the latest GfK survey, and inflationary pressures in the service sector persist.
Despite these challenges, UK equities have attracted global investors. HSBC’s strategy highlights the appeal of defensive sectors as earnings growth continues to deteriorate.
The outlook for earnings-per-share growth for the FTSE 350 has weakened consistently over the past year, with recent months seeing particularly sharp declines.
This has prompted the brokerage to adjust its sector weightings, taking a more defensive stance as the UK economy contends with mixed signals.
One of the changes HSBC made was its upgrade of the Telecoms sector to “overweight” from “neutral”.
The sector has benefitted from improving earnings momentum, aligning with HSBC’s broader European sector strategy.
The analysts cited a 10% outperformance in Telecoms relative to the FTSE 350 in 2024, supported by stronger demand for defensive stocks amid market volatility.
Despite accounting for just 1.3% of the FTSE 350 index, Telecoms is now positioned as a key area of potential growth.
The Real Estate sector was also upgraded to “overweight” from “underweight.” HSBC believes the sector is poised for recovery as the global rate-cut cycle gains momentum.
With UK-focused buy-side funds already positioned optimistically, HSBC expects falling interest rates to serve as a catalyst for further gains.
Real Estate, having underperformed in 2022, saw modest improvements in 2023 but still remains volatile. The bank’s upgrade reflects a growing confidence that the sector will benefit from lower debt costs and government-led housing initiatives.
Consumer Products and Services also saw a boost, moving to “overweight” from “underweight.” Despite a slow start to the year, the sector has outperformed the FTSE 350 by 8% in the third quarter of 2024.
HSBC’s optimism stems from improving earnings forecasts and momentum, particularly in housebuilding companies expected to benefit from lower borrowing costs and increased government focus on housing development.
Although the sector’s year-to-date performance is still slightly negative relative to the broader market, recent trends suggest a more positive outlook moving forward.
In contrast, HSBC has taken a more cautious stance on cyclical, commodity-driven sectors. The Basic Resources sector was downgraded to “underweight” from “overweight” as commodity price weakness, particularly in iron ore and oil, has begun to weigh on earnings expectations.
The sector has underperformed the FTSE 350 by 19% so far in 2024, making it the worst-performing sector with more than a 1% weighting in the index. HSBC notes that while earnings estimates have been inching upward, there remains downside risk if commodity prices continue to decline.
Similarly, Chemicals was downgraded to “neutral” from “overweight”. The sector, which accounts for less than 0.5% of the FTSE 350, has seen a volatile year, underperforming the broader index by 25% in 2024. Given its small weighting and lack of short-term growth catalysts, HSBC has opted for a neutral position.
The Energy sector faced a more severe downgrade, moving to "underweight” from “neutral”. HSBC’s analysts described the sector as being caught in a “value trap,” with weak short-term dynamics and fragile sentiment.
The 15% drop in Brent crude oil prices in the third quarter of 2024 has exacerbated the sector’s underperformance, which has fallen by 12% in the same period.
HSBC acknowledges that the sector’s fortunes are closely tied to future oil price movements, and without a rebound in crude prices, the outlook remains bleak.
Despite recent improvements in UK market performance, particularly in the FTSE 250, HSBC warns of ongoing challenges.
EPS growth forecasts for 2024 and 2025 continue to weaken, and while UK equities remain attractively valued relative to their historical averages, the risks of a sharper slowdown in activity remain elevated. Defensive sectors are likely to lead the way as investors seek shelter from macroeconomic volatility.