Conviction is growing among strategists that this year’s powerful European equity rally is set to falter.
After gains of more than 9%, the Stoxx Europe 600 index will end 2023 at 455 points, according to the average target in a Bloomberg survey of 16 market forecasters, implying a 2% drop from Friday’s close. Despite the sharp recovery and resilience shown by equity markets, strategists weren’t persuaded to make big changes to where they think the benchmark will close out the year.
“We remain positioned for a sharp loss in growth momentum over the coming months,” said Bank of America Corp. strategist Milla Savova. A temporary boost to the economy will fade during the second quarter, as the full impact of monetary tightening materializes, while earnings forecasts get downgraded, she said.
Europe’s ability to so far avoid recession, optimism around China’s reopening and surprisingly robust company earnings have helped propel the region’s equities. But Savova predicts about 20% downside for the Stoxx 600 to 365 by the third quarter, followed by a trough in the macroeconomic cycle leading to a renewed rebound in the benchmark by year-end to 430.
The cautious view is echoed at JPMorgan Chase & Co., where strategist Mislav Matejka says key monetary indicators are “sending warning signs,” such as tightening money supply and a yield curve inversion pointing to a recession ahead. Those are red flags that should “not be dismissed lightly,” he says, forecasting no upside for the Stoxx 600 from current levels.
Matejka says the impact of monetary policy tends to be felt with a lag on the real economy, taking as long as one to two years to play out, and he sees the rally fading during the first quarter, after marking the high point of the year for stocks. “The damage has been done, and the fallout is likely still ahead of us.”
The strong performance of European equities this year has extended a powerful rally for the benchmark index that started at the end of September to more than 21%. The Stoxx 600 has outperformed its US counterpart — the S&P 500 — by nine percentage points in the respective local currencies, and by as much 20 percentage points in dollar terms over that period. The UK’s FTSE 100 exceeded 8,000 points for the first time last week, marking fresh all-time highs, while the French CAC 40 is flirting with a record level.
Resilient macroeconomic data, the revival of Chinese demand, as well as easing inflation have provided major tailwinds for markets. Cyclical stocks including autos, retail, travel and banks have led the rally since the start of the year, helped by a mild winter that allowed European economies to avoid a deeper energy crisis. Meanwhile, the fourth quarter earnings season has been reassuring so far, prompting analysts to raise EPS estimates again.
Data today showed that Euro-area business activity rose at the fastest rate in nine months in February — raising the likelihood that the bloc can avoid a downturn this quarter. The better-than-expected performance was driven by services, which saw the strongest growth since June in surveys of purchasing managers by S&P Global. Manufacturing output also improved as supply-chain bottlenecks eased further
The range of predictions for the benchmark index remains wide, with ZKB having the most optimistic target of 510 points, suggesting nearly 10% upside from Friday’s close. TFS Derivatives has the most pessimistic view at 380 points, representing 18% downside.
“Recession risks have not abated — quite the opposite,” said TFS Derivatives strategist Stephane Ekolo, who regards market participants as too complacent and who expects analysts to quicken the pace of earnings estimates cuts. “Given the wage price spiral, elevated material costs and higher cost of energy, margins are likely to be negatively impacted.”
For European investors, a lot of the good news is already in the price, according to February’s BofA European fund manager survey. In fact, 53% of respondents see stocks falling over the coming months, with more central bank tightening and earnings downgrades the most likely causes of a decline. They are also much less optimistic in the medium term compared to last month, with just 55% seeing upside over the next 12 months, down from 70% in the January survey.
“The air has become thin for further price gains,” said UniCredit SpA equity strategist Christian Stocker, predicting volatility ahead and barely any upside for the Stoxx 600 in his 470 points year-end target. “With the momentum of disinflation decreasing, pressure is mounting for central banks to hike more than anticipated.”