Optimistic European equities outlook for the remainder of the year – Morgan Stanley

After performing strongly for much of this year, European stocks have traded sideways over the last month. But a closer look at the data suggests an optimistic outlook, as Graham Secker, head of Morgan Stanley's European and UK Equity Strategy team, notes.

Recent pause in Europe's outperformance not concerning

“Underlying fundamentals behind the European equity market remain strong, with the region currently seeing a faster pace of earning upgrades than anywhere else. From an economic perspective, the data also continues to come in better than expected, with the Eurozone enjoying the best economic surprise index of any major global country or region.” 

“Eurozone inflation expectations have remained towards the top of their recent range and have not followed the drop we've seen in the US since the last Federal Reserve meeting in mid-June. Against this backdrop, we think it is hard to argue that the recent underperformance of European equities is due to fundamental growth concerns. Instead, we think it is down to a partial unwind of the global reflation trade, post this last Fed meeting.”

“The recent fall in US bond yields has taken many people by surprise and undermined the reflationary narrative that had previously been boosting cyclical companies and those stocks with more of a value bias. While this uncertainty may persist for a little longer through the summer, we expect investor confidence to recover as we move towards the latter stages of the year, helped by a continuation of healthy economic data and higher bond yields. Our US bond strategists expect US 10-year yields to end the year much higher than they are today, at 1.8%.”

“As yields rebound, we'd expect European equity outperformance to return and note that the level of global investor engagement with the region remains high. In addition, we are also seeing a sharp acceleration in mergers & acquisitions, most noticeably in the UK, where activity is running at double the pace seen in the US and the rest of Europe. One catalyst here is likely to be the UK equity market's very low starting valuation. The UK is the only major world stock market where valuations are below their 10-year average – whereas they remain close to decade highs in all other regions.”