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Roula Khalaf, editor-in-chief of the FT, selects her favorite stories in this weekly newsletter.
The author is chief European equity strategist at Morgan Stanley.
Over the past year, European stock markets have confounded many observers, decoupling from macroeconomic indicators and generally continuing to rise despite a significant reassessment of the expected extent of central bank interest rate cuts. Recent economic cycles are not a good guide, but if we look back almost three decades we can find a cycle with eerie similarities to today’s.
Specifically, in 1995, after a period of rising interest rates, Fed Chairman Alan Greenspan unveiled what ultimately became the “Fed pivot,” stating that “the Fed will likely be able to contain price increases without any difficulty.” A few months later, Germany’s Bundesbank – at the time a pioneer among European central banks – also backed away from rate hikes and looked toward future cuts. European stocks were already on a run, following the rise in US stocks. Academic studies would later refer to the period that followed as a “perfect soft landing,” something unforeseen at the time.
This 1995 Fed pivot and soft landing playbook can serve as an important guide to rising European stock markets today. Certainly, Europe’s economic growth is mediocre compared to that of the United States, but that was also the case in the mid-1990s. Germany and Italy experienced near-zero GDP growth shortly after. after the pivot.
Also similar are the themes of technological innovation, relatively tight labor markets, US inflation at levels very similar to today, and mixed but overall positive economic data. Essentially, consistently stronger-than-expected employment and inflation data in the mid-1990s meant the Fed cut interest rates later and more slowly than investors initially expected.
As we explained in a recent report, European stock valuations are being boosted in the same way they were in 1995, amid hopes of future rate cuts, improving economic data and confidence companies generally feed the markets. MSCI Europe’s forward price-to-earnings ratio has fallen from just under 12 times at the October 2023 market lows to around 13.5 times today. By the end of 1995, MSCI Europe stock valuations had increased nearly 15-fold and continued to rise, despite only two Fed rate cuts in the first post-Fed pivotal year. Likewise, the total volume of M&A deals in Europe is rising sharply year-over-year from cycle lows, just as it did in 1995. Even the recent tactical pullback in European stocks has coincided almost exactly with the one that occurred at this phase of the rally in 1995.
European earnings revisions are already in the early stages of a recovery from record lows. Our model of macroeconomic and bottom-up predictive indicators suggests that this trend will continue steadily through the current earnings season and into the remainder of 2024. Our leading indicators point to 8% earnings growth for MSCI companies Europe by the end of the year, double the analyst consensus.
There are other reasons to be bullish on European stocks, beyond even the bullish comparison of 1995. Our recent analysis of 20 years of earnings and conference season transcript data indicates that companies European countries benefit from a wave of positive themes. The diffusion of AI, capital distributions including share buybacks and dividends, margin discipline and mergers and acquisitions are all increasingly common topics in European leaders’ conversations.
Mentions of “green shoots” in these conversations are increasing rapidly, as was the case in 2009, while discussions of “economic uncertainty” and “energy costs” are declining sharply. It is worth remembering here that European stocks are not equivalent to the European economy. More than 60 percent of the MSCI Europe Index’s market-cap-weighted revenue exposure comes from regions outside Europe, particularly the United States, which accounts for 25 percent. Much of Europe’s recent strength comes from its world champions, and we hope this trend continues. For example, Novo Nordisk, ASML and SAP contributed about 70 percent of the MSCI Europe’s annual rise in dollar terms.
So what could possibly go wrong with this “Goldilocks” setup? One area we have analyzed recently is Europe’s exposure to possible policy changes after the US elections. However, we find that this exposure is much more idiosyncratic – and limited to certain stocks – rather than widespread. The 1995 comparison has so far proven to be an accurate guide, but 1995-1996 did not see any significant exogenous shocks. If an unexpected and significant risk event occurs, or if a number of current risks worsen, it could divert the price away from the bull market. But for now, we expect European stocks to continue partying like it was 1995.
