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European Stocks Show Resilience Amid Expectations of ECB and Bank of England Rate Cuts

European Stocks Poised for Continued Rally Amid ECB Rate Cut Expectations and Positive Earnings Outlook

By Athena Xu

4/4, 05:27 EDT
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Key Takeaway

  • European stocks show resilience with the Stoxx 600 index maintaining an upward trend amid expectations of ECB and Bank of England rate cuts.
  • Cyclical sectors like autos, banks, mining, and energy poised for gains against a backdrop of slowing inflation and rallying commodity prices.
  • Despite stretched valuations with a P/E ratio at 14.1 times, the upcoming earnings season could boost confidence in European equities.

European Stocks' Resilient Performance

European equities have demonstrated a robust performance, marking the best quarter in a year despite a recent slowdown in momentum. The Stoxx 600 index, after reaching a record high, has seen its overbought condition ease, yet the upward trend established since October continues to hold strong. This resilience comes amid rising Treasury yields and a cautious stance from the Federal Reserve regarding interest rate cuts. Barclays has recently shifted its stance on European stocks to a tactical overweight, citing several factors that could fuel further gains. These include a revival in domestic growth, improved activity in China, the possibility of more aggressive rate cuts by the European Central Bank (ECB) and the Bank of England compared to the Fed, attractive valuations, and a tilt towards value-cyclical stocks.

Inflation, Rate Cuts, and Sector Performance

The European market landscape is witnessing a slowdown in inflation, with traders anticipating the first rate cut as early as June. This macroeconomic backdrop is particularly favorable for cyclical sectors such as autos and banks, which are poised for outperformance in a broadening equity rally. Additionally, sectors like mining and energy are benefiting from rallying commodity prices this month. Despite these positive indicators, Barclays cautions that factors such as a heated economy, high geopolitical risks, and frothy market technicals could necessitate some consolidation, tempering the "Goldilocks narrative."

Valuation Concerns and Earnings Outlook

The broad rally in the Stoxx 600 has pushed its forward price-to-earnings (P/E) ratio to 14.1 times, a level considered stretched by some analysts given the prevailing sovereign yield rates and negative earnings revisions for 2024. Bloomberg Intelligence suggests that more aggressive cuts by the ECB are necessary to justify the current market valuations. On a brighter note, the upcoming first-quarter earnings season is anticipated to be a catalyst for the next leg of the European stock rally, with analysts expecting a 4% rebound in profits for 2024 after a slump last year. This optimistic earnings outlook, coupled with a shift towards earnings upgrades, could reinforce investor confidence in European equities.

Street Views

  • Barclays (Bullish on European stocks):

    "Barclays upgraded European stocks to tactical overweight on Wednesday, seeing catch-up potential given a pick-up in domestic growth, better China activity, potential for more rate cuts by the ECB and the BOE versus the Fed, cheaper valuations and a value-cyclical tilt."

  • Citi Quantitative Strategists (Bullish on Euro Stoxx 50 and DAX):

    "European bullish flows have continued in the past week with over $2 billion of new longs to the Euro Stoxx 50 and nearly the same amount on the DAX, along with continued ETF inflows."

  • Laurent Douillet, Bloomberg Intelligence (Neutral on Stoxx 600):

    "The Stoxx 600’s broadening rally lifted its forward P/E ratio to 14.1x, which is 'a stretch' as two- and 10-year EU generic sovereign yields remain above 2% and 2024 earnings revisions are still negative... More aggressive ECB cuts are needed to justify a higher valuation."