Hedge Funds Are Cautious on Stocks amid Rates and Energy…

PodcastGoldman Sachs The MarketsMark WilsonOct 9

Wilson highlights French budget uncertainty and widening OAT spreads, while arguing that German fiscal spending is supporting industrial investment and AI could help counter Europe’s demographic challenges. European stocks’ negative correlation with 10-year yields and rate-driven equity derating underscore the market impact of inflation and energy risks. Investors have reduced equity exposure, even as Wilson points to European investment themes and forecasts strong earnings growth on both sides of the Atlantic.

Equities Interest Rates Market Valuations

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Key Takeaways

Wilson sees France’s widening OAT spreads and budget concerns as a Europe-specific risk likely to persist over the next few months as the country approaches presidential elections in the first half of next year. Separately, he sees a possible window for news and a break in the Iran conflict ahead of the midterms, but not as a certainty.

Wilson argues that AI deployment could help offset Europe’s demographic challenges by lifting output in demographically challenged areas, challenging the view that demographics alone make Europe a value trap. He also says Europe’s discount partly reflects its lower exposure to technology and high-growth companies.

Wilson says Germany’s ability to expand fiscally, while other countries worry about fiscal space, is helping drive investment across its industrial complex and contributing to manufacturing PMIs that are outpacing those in the U.S. He also points to investment cycles in European industrials, renewables, and defense, alongside the push for energy independence.

GEO-POLITICS

French Budget Risk — Wilson says widening OAT spreads versus Bunds and political concerns over France’s upcoming budget are major Europe-specific issues. He expects them to persist over the next few months as France approaches presidential elections in the first half of next year.

“Oats spreads versus buns have blown out, and some of the social but mainly political issues focused around the upcoming budget in France have been a real problem…”—

TECHNOLOGY

AI and Demographics — Wilson argues that AI deployment could help offset Europe’s demographic challenges, with economic agents lifting output in demographically challenged areas. He says this challenges the view that demographics alone make Europe a value trap.

“This argument around demographics is destiny, I think, is somewhat being debunked when we think about the real power of AI and the deployment of AI, which will be very…”—

ECONOMY

German Fiscal Push — Wilson says German manufacturing PMIs are outpacing those in the U.S., partly because Germany can expand fiscally while other countries worry about fiscal space. He says the spending is driving investment across Germany’s industrial complex.

“German manufacturing PMIs are actually outpacing The US right now…”—

MARKETS

Stocks and Bonds — Wilson says European stocks and 10-year bond yields have a six-month correlation of about negative 70, a degree of negative correlation not seen since the 1990s. He links Europe’s greater vulnerability to the energy shock with higher inflationary pressure.

“In Europe, we are more vulnerable to the to the energy shock, and so the inflationary pressure is higher…”—

Rate-Driven Derating — Wilson says higher rates have driven an equity derating. European renewables, a rate-sensitive area, have derated by well over 20%.

“So S and P multiple has come down. Same is true in Europe…”—

Lower Equity Exposure — Wilson says fundamental long-short investors have cut positioning in response to rates and other uncertainties. U.S.-focused funds’ net length is at the second and third percentiles on three- and five-year lookbacks, respectively; global funds’ net length ranges from zero to 9%.

“And if you look at US specific fundamental long short clients today, their net length is in the North percentile on a one year look back…”—

Rates, Energy, And Positioning

Wilson says Europe is especially exposed to energy-driven inflation, French budget uncertainty is widening OAT spreads, and rising rates have prompted investors to sharply reduce equity exposure.

European Energy And Valuations

Wilson says high energy costs are a competitive headwind for Europe but are partly reflected in cheaper valuations, leaving room for performance despite the risks.

Europe’s Investment And AI Case

Wilson points to industrial investment, defense, energy independence, and AI as potential supports for Europe, arguing that these themes challenge the value-trap case based on demographics.

Earnings And Investment Trades

Wilson expects strong earnings growth in the US and Europe and favors US mega-cap technology and German fiscal-spending beneficiaries, while watching CPI, geopolitical developments, and earnings.