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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chief European equity strategist at Morgan Stanley
Over the past year, European equity markets have confounded many observers, decoupling from macro indicators and broadly continuing to grind higher despite a significant repricing in the expected magnitude of central bank interest rate cuts. Recent economic cycles have not served as a good guide, but looking back almost three decades, we can find a cycle with uncanny similarities to today.
Specifically, in 1995, after a period of rising interest rates, Fed chair Alan Greenspan unveiled what ultimately became the ‘Fed pivot’, stating that “the Fed likely will be able to contain price increases with little difficulty”. Months later Germany’s Bundesbank — the trendsetter for European central banks at the time — also pivoted away from rate hikes and towards future cuts. European equities were already off to the races, following US stocks higher. Academic studies would later point to the period that followed as the ‘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. Sure, Europe’s economic growth is lacklustre compared to the United States, but this was also the case in the mid-1990s. Germany and Italy registered close to zero GDP growth soon after the pivot.
Also similar are the themes of technological innovation, relatively tight labour markets, US inflation at levels very similar to today and mixed but broadly positive economic data. For the most part, consistently stronger than expected labour and inflation data in the mid-1990s meant the Fed cut interest rates later and more slowly than investors initially expected.
As we argued in a recent report, European stocks’ valuations are being boosted in much the same way as they were in 1995, as hopes for future rate cuts, improving economic data and generally rising corporate confidence fuel markets. MSCI Europe’s forward price/earnings ratio has increased from just under 12 times at October 2023’s market lows to about 13.5 times today. By the end of 1995, MSCI Europe’s stock valuations had increased to nearly 15 times and continued heading higher, despite only two Fed rate cuts in that first post-Fed pivot year. Similarly, Europe’s aggregate M&A deal volumes are rising sharply year-on-year from cycle lows, just as they did in 1995. Even the recent tactical pullback in European equities coincided almost exactly with one that occurred at this phase of the rally in 1995.
European earnings revisions are already in the early stages of a recovery from trough levels. Our model of predictive macroeconomic and bottom-up indicators suggests this will continue steadily through the current earnings season and the rest of 2024. Our leading indicators point to 8 per cent earnings growth for MSCI Europe companies by year-end, double the analyst consensus.
There are further reasons to be optimistic on European equities beyond even the bullish 1995 comparison. Our recent analysis of 20 years of earnings and conference season transcript data indicates that European companies are benefiting from a wave of positive themes. The spread of AI, capital distributions including share buybacks and dividends, margin discipline, and M&A are all becoming more common in European C-suite conversations.
Mentions of “green shoots” in these conversations are increasing rapidly, as they did in 2009, while talk of “economic uncertainty” and “energy costs” is falling sharply. It is worth remembering here that European equities are not equivalent to the European economy. Over 60 per cent of the market capitalisation-weighted revenue exposure of the MSCI Europe index is from regions outside of Europe, in particular the US, accounting for 25 per cent. A lot of Europe’s recent strength is coming from its global champions, and we expect this trend to continue. For example, Novo Nordisk, ASML and SAP have driven about 70 per cent of MSCI Europe’s year-to-date rally in dollar terms.
So what could go wrong with this ‘goldilocks’ set-up? One area we have analysed recently is Europe’s exposure to potential policy changes after the US election. However, we find this exposure is far more idiosyncratic — and limited to select stocks — rather than broad-based. The 1995 comparison has been an accurate guide thus far, but 1995-1996 lacked any meaningful exogenous shocks. Should an unexpected and material risk event occur, or any number of current risks escalate, it could divert the course of the bull market. But for now, we expect European stocks to keep partying like it’s 1995.
