European stocks only undergoing a technical correction, BofA Merrill says

In 2016, European stocks got off to one of their worst starts to a year in history but the economy was still improving and valuations were “decent” so the structural up-trend continued to be in place, one of the world’s largest brokers said on Friday.

Chinese stocks dropped 6% on the first day of trading and the yuan depreciated again, alongside a slide in oil below the $35 per barrel mark, bathing traders’ screens in red on Monday, strategists at Bank of America-Merrill Lynch said in a research report sent to clients.

Yet at 3.9% European stocks continued to offer a “very good” yield compared to other asset classes.

"We see this as a technical correction where long positions looking for the usual January rally are being flushed out"

So while markets would continue exhibit volatility until China and commodities stabilised, they recommended investors “buy the dips”.

"We see this as a technical correction where long positions looking for the usual January rally are being flushed out of the system, rather than being a fundamental change of trend."

However, increased volatility to successive ‘shocks’ – as a result of lower liquidity in markets and changing trading patterns – meant investors would also need to stand ready to sell rallies.

“Right now we think markets are close to a near term low and would look to add risk into this weakness,” they said.

Their favourite or so-called ‘overweight positions were “selective” cyclicals, particularly technology, industrials and media.

That was due to their low or non-existent exposure to risks from emerging markets.

They also still liked banks, believing the regulatory cycle would not bar dividends in 2016, although lenders' ability to remunerate their shareholders would be tested.

Healthcare was another favourite because of the yield offered by the sector and the fact that markets were underestimating the pipeline potential.