The European Central Bank’s decision to lift rates by a record 75 basis points (8 September) came as no surprise. After all it was playing catch up with its global counterparts in moving to address the current inflationary pressures by lifting rates.

The ECB has different considerations than other central banks because it has to manage the interests of a whole economic bloc but Reuters has reported sources outlining a scenario where rates may have to increase to at least 2%.

Given that prior to July’s 50 basis point increase rates had been at our below zero for some time this would represent a big change and could exacerbate a downturn in the Eurozone economy.

What are the implications for European stocks and just what has been priced in by markets? There is no doubt the European market trades at a significant discount to the US market and materially below its long-term average. This has happened despite European earnings being upgraded by 14% in 2022 according to Morgan Stanley.

However, there’s still a good chance European shares could get even cheaper in the eyes of the investment bank’s equity strategy team, led by the widely-followed Graham Secker.

Secker and his colleagues see a risk that the price to earnings ratio for European stocks will hit 10 times, implying a double-digit fall from current levels.

They comment: ‘We remain cautious on European equities against a backdrop of heightened geopolitical/energy uncertainty and where central banks continue to tighten monetary policy into a deepening economic slowdown.’

Secker and co also observe that the 17% increase in earnings per share forecast for 2022 would have been just 7% if you strip out the impact of the energy sector. They also argue forecasts for 2023 earnings growth of 2% look optimistic given a highly uncertain backdrop – not least the pressure on margins from soaring input costs. What about the longer-term picture though?

Writing in July before the most recent surge in gas prices which greeted Russia’s shutdown of the Nord Stream 1 pipeline, BlackRock argued: ‘Europe is home to many “best-in-class” companies that we believe are well positioned to help global governments meet their net-zero emissions targets.’

BlackRock adding that: ‘We believe European stocks now represent good value for investors seeking to capitalise on recent market volatility to gain exposure to long-term structural trends – such as the shift to a net-zero future.’

The argument over European valuations won’t dissipate soon, barring a miraculous turnaround in fortunes. What is true is European stocks are often unfairly overlooked by UK investors given the breadth and depth of the market and Shares will continue to look to mainland Europe for quality opportunities even as this valuation debate continues to rage.

‹ Previous2022-09-15Next ›