March 28, 2014 / 12:05 PM / 4 years ago

RPT-GRAPHIC-European stock sector divergence to narrow as EM concerns ebb

* Emerging market ructions marred Europe Q1 performance

* Fuelled demand for domestic, drove sector split

* Impact seen ebbing in Q2 as bond yields rise, EM bottoms

* Growth-exposed sectors to outperform defensives

By Simon Jessop and Vincent Flasseur

LONDON, March 28 (Reuters) - Emerging market ructions have driven a divergence in sector performance on European bourses this year that is likely to ebb in the second quarter as investors become more confident about global economic recovery.

A slowing Chinese economy, concerns over the impact of U.S. stimulus withdrawal on various currencies and uncertainty over tensions in Ukraine have pushed investors out of EM-exposed firms and into domestically focused sectors and companies.

Southern European stocks have reaped the greater part of the outflow from volatile emerging markets as investors targeted cheap stocks to play a recovering economy, albeit with slim earnings support.

That has left a mix of high-yielding “defensive” sectors and growth-focused “cyclical” sectors at both ends of the performance chart, an abnormal position that is likely to begin correcting in the second quarter.

After chalking up a 17 percent gain in 2013, the STOXX Europe 600 has flatlined. Sectorally, defensive utilities are up 7.6 percent this quarter, which has just one trading day left, and growth-focused construction & materials’ stocks are up 5.1 percent.

The worst-performing sectors are defensive telecoms, which have slipped 3 percent and more growth-focused retail stocks, down 2.7 percent.

“There are a few cross-currents in the market, which is why the sectoral performance is not as straightforward as you might expect,” said Ian Scott, head of equity strategy at Barclays.

Looking to the second quarter, Scott said some of the drivers of that divergence would begin to slow, with companies exposed to emerging markets making up ground.

“I think people will look more favourably on emerging markets. They certainly look rather cheap to us. And the mounting evidence of global recovery will help them,” Scott said.

"Within Europe, we'll see that feed through into the revenues of companies, although people want to see it before raising forecasts for 2014." [Graphic on year-to-date STOXX Europe 600 sector performance: ]

Among other houses flagging EM as a buy, with varying degrees of caution, are Societe Generale, HSBC and Citi.

A slide in corporate bond yields over the first quarter helped many companies lock in cheap long-term funding and would boost profitability, said Scott, while renewed optimism about economic growth would crimp demand for defensive sectors.

While uncertainty over growth and potential policy responses in China will continue to hang over markets, Emmanuel Cau, equity strategist at JPMorgan, said the performance charts were likely to get a shake-up if U.S. data picks up and pushes developed market bond yields higher.

“Everyone was expecting bond yields to go up this year, on the back of stronger growth, but it did not work out. We think bond yields will go up 20-30 basis points in the second quarter and that should be supportive of most cyclical sectors.”

“But we still want to differentiate, we don’t want to be involved in companies that have a big exposure to emerging markets, such as materials.” (Editing by Susan Fenton)

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