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Pessimism Ebbing Among Most-Bearish European Strategists

July 13, 2012

Pessimism Wanes Among European Strategists

A financial trader monitors data on computer screens at the Frankfurt Stock Exchange in Frankfurt. Photographer: Simon Dawson/Bloomberg

European stock strategists are backing away from their most-pessimistic forecasts as policy makers agree on measures to tackle the region’s debt crisis.

While sticking to predictions for losses of as much as 16 percent, Morgan Stanley’s Ronan Carr raised his recommendation on European equities to neutral on July 2 and Alain Bokobza of Societe Generale SA said he has started to reduce the underweight call he’s had for at least two years. Exane BNP Paribas said investors can find bargains among companies most reliant on economic growth.

Exane, Morgan Stanley and Societe Generale projected average 2012 declines of 13 percent in European stock indexes at the end of last year, the biggest among 16 banks and brokers polled by Bloomberg in December. The Euro Stoxx 50 Index (SX5E) has slipped 3.8 percent this year, dragging its valuation to 0.93 times book value, cheaper than any time except the week markets bottomed in March 2009, according to data compiled by Bloomberg.

“If we get positive follow through from European Union policy makers in the coming weeks, last month’s summit will likely represent a substantial improvement in the risk-reward outlook for European equities,” Carr said in a phone interview from London. “Stocks aren’t expensive.”

SocGen’s Bokobza lifted his 2012 projection for the Stoxx 600 to 220 from 210 at the start of the year. That’s 13 percent below the current level. Morgan Stanley’s year-end target for the MSCI Europe Local Index is 870, about 16 percent below yesterday’s close.

Bailout Flaws

The Stoxx Europe 600 Index (SXXP) climbed 3.4 percent through yesterday after euro-area leaders agreed to address flaws in their bailout programs in an announcement on June 29. Policy makers eased repayment rules for Spanish banks, relaxed conditions for possible aid to Italy and unveiled a $149 billion economic growth plan.

The gains have brought the Stoxx 600’s advance in 2012 to 3.4 percent. The three most bullish brokerages polled by Bloomberg in December -- Royal Bank of Scotland Group Plc, Nomura Holdings Inc. and Citigroup Inc. -- predicted an average 26 percent rally in European stocks this year. The Stoxx 600 climbed 1.3 percent to 256.26 today.

The Euro Stoxx 50 of the biggest euro-region companies fell to 0.93 times book value, or assets minus liabilities, last month as concern grew that Greece will be forced to drop out of the euro, data compiled by Bloomberg show. That was the cheapest since March 6, 2009, the week that preceded a 70 percent rally in the equities gauge.

Depressed Valuations

“Valuations are extremely depressed,” said Ian Richards, head of equity strategy at Exane, who recommends mining, industrial, media and construction shares. “That and positive policy catalysts make a strong argument for investing in stocks.” Richards joined Exane in April from Royal Bank of Scotland Group Plc.

Carr and his Morgan Stanley team upgraded insurance stocks to overweight this month, saying the industry is inexpensive, and cut consumer staples to underweight as valuations rose. An overweight recommendation means investors should hold more of the stocks than are represented in benchmark indexes.

Stoxx 600 insurance shares trade at 7.3 times estimated earnings, compared with a five-year average of 8.4, Bloomberg data show. Consumer staples in the MSCI Europe Index trade at 15.2 times projected profit, close to the highest level since 2010, according to the data.

Economy Shrinks

Even so, Europe’s deepening debt crisis, which has pushed borrowing costs to euro-era records in Greece, Spain and Italy, combined with weak economic growth create potential hazards for equity investors, Carr said. The euro-area economy will shrink in the final three quarters of 2012, resulting in a 0.4 percent annual contraction, economist forecasts compiled by Bloomberg show.

“Underlying solvency concerns in Greece and in Spain remain,” Carr said. “We would expect growth expectations to remain under pressure, which will act as a headwind to markets.”

Investors’ pessimism on European stocks suggests they may be liable for a rebound if the region’s policy makers reinforce their response to the debt crisis, according to SocGen’s Bokobza. In a survey of fund managers released by Bank of America Corp. on June 12, a net 36 percent of respondents were underweight Europe, meaning they hold fewer assets in the region than are represented in global benchmarks.

‘So Pessimistic’

“Decisions are starting to improve and governance is starting to be put into place,” Bokobza said. “We have a scenario that’s so pessimistic and there is so little positioning in European stocks that we can have relative performance as investors return.”

Leaders of the 17 euro nations meeting last month dropped the requirement that governments get preferred-creditor status on crisis loans to Spain’s banks and opened the door to recapitalizing lenders directly with bailout funds once Europe sets up a single banking supervisor. They also discussed reducing the market pressure on Italy and Spain by allowing them to access rescue loans without relinquishing control of their economies.

The European Central Bank followed the June 28-29 European summit by cutting interest rates to a record low on July 5. The same day, the Bank of England restarted its bond buying program after a two-month hiatus.

2011 Forecasts

None of the banks and brokerages surveyed by Bloomberg at the end of 2010 successfully predicted that European stocks would fall last year. The 13 strategists forecast an average increase of 11 percent, while the Stoxx 600 finished the year 11 percent lower at 244.54.

Exane had forecast the Stoxx 600 would end last year at 305 and SocGen predicted a 310 closing level. Morgan Stanley had estimated a 2011 close of 1,250 for the MSCI Europe Local, which finished at 1,026.5.

Even after recent economist reports missed forecasts, action by policy makers, including a possible third round of quantitative easing from the Federal Reserve, bode well for stocks, Exane’s Richards said. Releases last week showed that American employers added fewer workers to payrolls than predicted in June, while U.S. service industries expanded at the slowest pace since January 2010.

“The near-term data is causing some concern, but there is a widespread response,” said Richards. “We think there will be QE3 in the U.S. by September. Earnings expectations aren’t stretched. We think they’re achievable. ”

To contact the reporter on this story: Adria Cimino in Paris at acimino1@bloomberg.net

To contact the editor responsible for this story: Andrew Rummer at arummer@bloomberg.net


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