European stocks: there’s life in the old cat yet

As seasoned market watchers know, even the most moribund of felines can ricochet off the pavement. Indeed, the propensity for equities to stage brief — groundless — rebounds in a bear market was in full evidence last summer in the US. But the recent strong showing in European equities — with the Euro Stoxx 600 up about 10 per cent since August 2022 — could prove more durable.

Granted, European companies are unlikely to post strong earnings in 2023. Consensus earnings per share growth is a measly 0.6 per cent, according to Sarah McCarthy at Bernstein. And even that may be too high, as Lex has recently warned.

The economy may no longer be expected to tank. But a mild recession is still likely. And margins do not yet reflect the squeeze from higher supply costs.

In that — admittedly gloomy — context, some sectors will probably get a lift from China, where Covid-19 restrictions are being removed faster than expected.

Luxury goods is one of these. LVMH, the sector juggernaut, is already pricing in a strong 2023. Richemont, the watchmaker, and leather-goods icon Hermès are also exposed to the Chinese consumer. Travel and leisure groups should also benefit: Tui is up 30 per cent this year, while British Airways parent IAG is up 28 per cent.

The reopening of the Chinese economy is not unequivocally positive for the European economy: it brings with it the risk of higher commodity prices, and thus higher input costs. Liquefied natural gas is a particular concern, as demand from China may drive up European energy prices for next winter. That would be bad news for energy intensive sectors, such as chemicals, fertilisers, cement and steelmaking.

Exporters in general are expected to do well. German stocks have traditionally outperformed their European peers when China outperforms the rest of Asia, as Morgan Stanley notes.

There are two more reasons not to dismiss the recent rally in European equities.

First, they are relatively cheap, on 12.5 times forecast earnings. When the end of a recession is in sight, the multiple has in the past risen to 14-15 times, according to Bernstein analysis.

Second, European equity funds have suffered net outflows since Russia invaded Ukraine, with $100bn lost in 2022. That is sizeable potential demand for European equities — and no one wants to miss out on a recovery.