European Stocks Surge but Strategists Remain Cautious for Year-End

European Stocks Surge but Strategists Remain Cautious for Year-End 

The economic outlook and corporate profits might be improving, but strategists remain cautious about becoming significantly more optimistic for the remainder of the year.

This sentiment is reflected in a monthly survey, which indicates that European stocks have possibly surged too much, gaining around 9% this year. According to an average prediction from a poll of 14 equity strategists, the Stoxx Europe 600 Index is expected to close the year at 503 points, 4% lower than last Thursday's close. The median forecast has slightly increased to 513 points, aligning with levels seen earlier this month.

Some strategists, including the most bearish ones from Bank of America, TFS Derivatives, and ING, have raised their targets compared to last month. However, none anticipate gains from the current levels.

"We remain pessimistic about European equities," say BofA strategists led by Sebastian Raedler, who adjusted their year-end target from 430 to 460 this month, indicating over 12% potential downside.

They acknowledge that decreasing US inflation could temporarily boost the market through a dovish shift in Fed policy expectations. However, they believe worsening US labor-market conditions will eventually dominate, increasing risk premiums and reducing EPS expectations.

Earnings have exceeded expectations so far. The first-quarter results in Europe have surprised positively, prompting upgrades in corporate profits and fueling market rally expectations.

"The earnings season, initially expected to be weak, turned out better than feared overall," say BNP Paribas strategists led by Georges Debbas, noting that three-quarters of companies met or exceeded earnings expectations, with margins improving unexpectedly.

"Disinflation and other factors could pressure European margins," say Citi strategists led by Beata Manthey, who have a more optimistic target of 540. "Nonetheless, we maintain our forecast of solid European EPS growth of +6% in 2024, which should justify some additional equity gains by year-end."

Additionally, the divergence in monetary policy compared to the US is likely to benefit the region's stocks. The European Central Bank has adopted a more dovish stance than the Fed recently, with bond markets anticipating rate cuts by the ECB before the US.

This has kept investors optimistic. According to the BofA European fund managers survey from last week, 78% of participants expect further near-term gains for European equities, up from 52% last month. About 51% believe the market's upside will be driven by a declining discount rate as falling inflation prompts the ECB to ease policy, while 37% are counting on earnings upgrades due to macroeconomic resilience.

"Despite the volatility in US rate cut expectations, we believe Europe's growth/policy mix is becoming more favorable," says Barclays strategist Emmanuel Cau, who also has a year-end target of 540 for the Stoxx 600. "We see early signs of economic improvement, and upcoming ECB/BOE rate cuts should create opportunities in the market."