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European Equities Outlook: Bad News Could Provide Support Amidst Earnings Recession and High Interest Rates

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European Equities Face Challenges, But Investors Remain Optimistic

Investors are finding reasons for optimism in the face of a potentially gloomy outlook for European equities. Although an earnings recession and high interest rates are expected, some experts suggest that much of the bad economic news has already been taken into account by the market. The recent war in the Middle East has led to a rush into safe-haven assets, but signals from central bankers that interest rates may not be raised further have pushed the pan-European STOXX 600 index close to three-week highs.

According to Jefferies, a mix of high interest rates, geopolitical tensions, and a weakening economy is typically unfavorable for stocks. However, in the current environment where surging bond yields have drawn funds away from equities, it is possible that “bad news is good news”. Strategist Mohit Kumar believes that any signs of weakness in the economy would lead to lower real yields, providing support for risky assets.

Deutsche Bank is recommending an overweight position in European equities, stating that weaker growth, earnings misses, and a reluctance among central banks to cut rates are already priced in. This leaves room for upside potential from positive surprises. European companies are expected to enter their first earnings recession since 2020, with STOXX 600 company earnings forecast to drop 11.4% year-on-year in the third quarter.

Despite these challenges, European stocks are considered to be better priced for a recession compared to their U.S. counterparts, according to Matthew McLennan, co-head of First Eagle’s Global Value team. McLennan suggests that the U.S. market is pricing a situation as if the economy is emerging from recession and has significant growth ahead, while the European markets are pricing a more complex reality.

Currently, the STOXX 600 trades at 11.6 times forward earnings, while the U.S. S&P 500 trades at 17.8 times. The STOXX 600 has seen a 6% increase in 2023, in contrast to the S&P 500’s 14% gain. Goldman Sachs anticipates positive, but low returns for the European market in the next 12 months.

Oliver Collin, co-head of European equities at Invesco, explains that the market has priced in an “Everest” scenario, where interest rates quickly rise and then drop just as rapidly. This, rather than a “Table Mountain” scenario where rates flat-line at higher levels. As a result, stocks that benefit from higher interest rates may be trading at a discount relative to the risks, presenting potential for upside.

Despite these positive indications, some sectors may face challenges. Collin suggests that Europe’s outperformers, such as chemical ingredients, luxury goods, and tech hardware businesses, might struggle due to their expensive valuations. However, defensive sectors like healthcare and consumer staples are favored by Ayesha Akbar, a multi-asset portfolio manager at Fidelity, who believes that the future looks challenging for European equities.

The weaker euro also supports the outlook for European equities, according to McLennan. The currency is on track for a third consecutive annual drop against the dollar. McLennan believes that the combination of favorable valuations and currency valuations could potentially lead to better performance for European equities compared to U.S. equities over time.

In conclusion, while the outlook for European equities appears challenging, investors are finding reasons to remain optimistic. Despite an expected earnings recession and high interest rates, the market has already priced in much of the bad economic news. Analysts suggest that stocks may be trading at a discount relative to the risks, providing potential for upside. However, certain sectors may face difficulties due to expensive valuations. Defensive sectors like healthcare and consumer staples are favored by some experts. The weaker euro also supports the outlook for European equities. Overall, investors believe that European equities have the potential to outperform their U.S. counterparts in the long run.

More detail via Reuters here… ( Image via Reuters )

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