By Carla Mozee, MarketWatch
It would be a “mistake” for the U.S. Federal Reserve to start raising interest rates on Thursday, say analysts at Deutsche Bank.
However, if policy makers make such a misstep, European equities could provide some shelter from a subsequent drop in U.S. stocks, they said.
Read : When is the Fed decision?
The analysts said bank, technology, utility and insurance shares in Europe have in the past performed well after the Fed raises rates, as they are “positively correlated” with the dollar and yields of the 2-year Treasurys /zigman2/quotes/211347045/realtime BX:TMUBMUSD02Y +4.47% .
“We think a rate hike now would be a mistake, as inflationary pressures are low, market-implied inflation expectations have dropped to levels at which the Fed has started easing in the past and financial conditions have already tightened significantly,” the Deutsche Bank analysts, led by Sebastian Raedler, wrote in a research note.
It’s still no slam-dunk the Fed will leave rates unchanged when the highly anticipated decision is released Thursday. Fed fund futures are pricing in a 23% chance of a September hike, and although that is down from 45% a month ago, some economists say the decision could go either way.
The risk of a rate increase isn’t off the table for this year either, with markets pricing a probability of 60% for such a move by the end of 2015, said Deutsche.
U.S. equities could fall by 5% to 8% when the Fed begins raising rates, Deutsche Bank warned. Casting back to rate increases in 1994 and 2004, U.S. stocks typically fell by roughly 7% in the first two months, driven by price-to-earnings declining by about 15%, while earnings growth “remained strong.”
This time around, “we think there is less downside for P/Es and less upside to earnings,” the analysts said.
European stocks are poised to outperform U.S. equities after a rate hike, in part as monetary support from the European Central Bank for the eurozone economy is in place, and as the dollar is likely to rise.
The dollar’s /zigman2/quotes/210561242/realtime/sampled EURUSD -0.2119% drive higher against the euro this year in anticipation of a rate-increase by the Fed has been supportive for European exporters, as a weaker euro makes their goods less expensive for their customers to purchase.
Deutsche’s basket of European companies with U.S. exposure has already performed well and said relative valuations “look expensive in aggregate.”
But companies that take in at least 40% of their total revenue from the U.S. and whose P/E relative to the market is below the long-term average include Dutch insurer Aegon NV /zigman2/quotes/201853546/composite AEG +0.99% /zigman2/quotes/204800863/delayed NL:AGN +1.33% , which owns Transamerica, and Qiagen /zigman2/quotes/204869908/composite QGEN -2.11% /zigman2/quotes/208965936/delayed DE:QIA -0.47% , a medical testing technologies company.
The two stocks have buy ratings at Deutsche. Aegon shares this year are down 10% and Qiagen are up about 18%.
Other companies in that same mix, but have hold ratings, include Fiat Chrysler Automobiles , French advertising heavyweight Publicis Groupe /zigman2/quotes/207669560/delayed FR:PUB +0.42% and Spanish blood-plasma maker Grifols /zigman2/quotes/208424563/composite GRFS -0.67% /zigman2/quotes/203805978/delayed ES:GRF +2.05% .
Meanwhile, analysts at Société Générale have said they favor Italian and French shares over German and U.S. names in the wake of the slide in global equities that took place late last month. Read more in ‘The Call’ section of Need to Know.