• Funds Blog
• November 2, 2024

Is the Time Right for European Stocks?

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Last week marked a tumultuous period for the UK bond and currency markets, with shocking volatility disrupting the financial landscapeThe yield on 10-year UK government bonds surged to an astonishing 4.921%, reaching its highest level since 2008. Meanwhile, the yield on 30-year UK bonds hit 5.455%, a peak not seen since 1998. The British pound, too, faced significant challenges, plummeting against the US dollar to below 1.22—a low not recorded for 14 months.

The upheaval within the British bond market evoked memories of the “Truss Crisis” of 2022, and even stirred fears of a debt crisis reminiscent of 1976. However, experts interviewed suggested that the underlying fundamentals of the UK economy remain relatively healthyThe surge in bond yields appears to be primarily driven by rising inflation expectations rather than fundamental instability.

In contrast to the UK’s challenging circumstances, European stock markets experienced an upswing, with all three major indices closing higher

Analysts from Citigroup and Deutsche Bank expressed optimism, suggesting a bull market for European stocks could be on the horizonNevertheless, questions linger about whether European stocks can escape the languor expected in 2024.

This situation raises the question: is this merely an instance of market overreaction?

Throughout the past week, sovereign bonds worldwide encountered significant fluctuationsThe yield on 10-year US Treasuries rose by 16.79 basis points, marking a near one-year highIn France, the yield on 10-year bonds soared to its highest level since October 2023, while German bonds rose above 2.56%, reflecting the highest levels observed since July 2024.

The selling frenzy, which included UK bonds, can be attributed to rising concerns regarding inflationThe latest December non-farm payroll data from the US indicated stronger-than-expected job growth, which could fuel economic expansion and price increases

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Similarly, preliminary inflation data for the Eurozone, particularly in Germany, showed signs of inflation resurgence, complicating the European Central Bank's future efforts against inflation and its potential interest rate cuts.

The focus on UK inflation has intensified recently, especially as inflation rates have shown an upward trend over the past few months, increasing from 1.7% in October to 2.3%, and further to 2.6% in November—the highest rate in nearly eight monthsAlthough the December Consumer Price Index (CPI) data will only be released this week, the previous momentum towards inflation has cast a shadow of uncertainty over future economic prospectsThis has further undermined expectations for a rate cut by the Bank of England, leading to a more conservative assessment of the UK's economic trajectory.

Persistent inflation, a budget plan that proposes increased taxes and spending, cautious rate-cutting policies, and recent warnings from Fitch Ratings regarding “significant uncertainties” in the UK real estate market have all heightened market tensions

Consequently, UK gilt yields have been more volatile compared to US Treasuries and Eurozone bonds.

Yet, the surge in UK long-term bond yields to their highest level since 1998 begs the question: is the UK bond market slipping into a new crisis?

On Thursday evening, Bank of England Deputy Governor Sarah Breeden addressed concerns about the market's behavior, stating that price movements have been “orderly.” British officials generally view the pressure on UK bonds as stemming from disturbances across the oceanBreeden further elaborated that many price fluctuations reflect global conditions, which is expected, as markets react to changes in fiscal outlooks.

Darren Jones, the Deputy Minister and Secretary to the Treasury, echoed this sentiment, emphasizing that the movements in UK government bond prices are in line with global market trendsMike Riddell, a portfolio manager from Fidelity International, also noted that the dramatic fluctuations in UK bond yields are not isolated but part of a broader global phenomenon

UK bond yields appear to be closely following the rise in US bond yields, with modest increases noted in German bond yields as well.

As for whether this is a temporary shock or a harbinger of systemic crisis, experts express that the likelihood of a large-scale stagnation or collapse within the UK financial system is minimalThey have not identified significant fundamental issues, suggesting instead that the recent turmoil in UK bonds represents a short-term response to inflationary pressuresLooking ahead, both the UK and US inflation rates are anticipated to remain under control, and both economies are positioned within a wider framework of potential rate cutsTherefore, significant fluctuations in the GBP/USD pair are unlikely, although UK bond yields may still experience slight tremors due to the Bank of England’s more measured approach to rate cuts.

Nevertheless, the situation does not imply the UK is out of the woods

The ability of the Chancellor of the Exchequer to adapt the budget in response to market reactions is critical.

In a report released last Thursday, Alejandro Cuadrado, an analyst at Banco de España, highlighted that capital outflows from the UK have contributed to rising bond yields and depressed the value of the poundShould fiscal challenges persist, the current situation could evolve into what he termed a “mini Truss moment.”

This Wednesday, the preliminary results of the UK’s December CPI and upcoming government bond auctions are expected to influence the short-term trajectory of UK bondsRecently, US Treasury prices have shown slight increases, but robust demand observed during a 30-year Treasury auction has alleviated some concernsThe imminent inflation data from the UK and market enthusiasm for bond purchases will be critical in determining whether UK bonds can secure a robust support level in the short term.

As for European stocks, is it time to consider renewed investment? Last week, US stocks witnessed broad declines, erasing previous gains in a downturn

Meanwhile, European markets demonstrated resilience, with the German DAX 30 index climbing 1.55%, the French CAC 40 up by 2.04%, and the UK FTSE 100 rising by 0.30%.

As US equities corrected, European stocks garnered favorable attention from Citigroup and Deutsche BankIn a research report released on the previous Monday, Citigroup analysts predicted an 11% increase in the European STOXX 600 index by 2025, suggesting that the time has arrived for reinvesting in European stocks, as bearish positions have reached extreme levels.

Maximilian Uleer, a noted bull on European equities at Deutsche Bank, set a target price for the STOXX 600 index at an ambitious 590 points by the end of 2025. He cites reasons for this bullish stance, including improving recovery trends in the Eurozone, decreasing political uncertainty, and opportunities presented by a new German governmentAdditionally, any stimulating plans enacted by China in the first quarter could provide external opportunities, while a stronger dollar may offset some negative effects from increased tariffs

These factors are likely to trigger “tactical outperformance” in European stocks.

Despite having gained only 6% in 2024 compared to the S&P 500's substantial 20% increase, questions arise about whether European stocks can overcome this slump and narrow the growth gap with their U.Scounterparts.

Looking ahead, the economic landscape for European equities appears cautiously optimisticAlthough the eurozone’s GDP growth is estimated at a meager sub-1% for 2024, the general consensus forecasts around 1.5% growth for 2025, suggesting a favorable recovery trajectoryFurthermore, easing liquidity expectations in both Europe and the UK could provide additional supportive macroeconomic conditions.

However, European equities face significant challenges in catching up with the growth trajectory of US stocksThe past couple of weeks have seen US markets adjusting, primarily due to investor perceptions of high valuations and an overconcentration of funds in a limited number of stocks, leading to potential corrections

Yet, after this period of consolidation, it is anticipated that the U.Smarket will likely re-enter a normal growth patternGlobal investors still favor US assets over euro-denominated ones, fueled by the IMF and other international institutions projecting U.Sgrowth above 2% this year, considerably outpacing Eurozone growth ratesMoreover, the current bull run in the U.Smarkets is largely attributed to the AI boom, while Europe has lagged in the pace of technological advancements, which may continue to result in smoother growth patterns for European stocks relative to the U.Smarket through 2025.

This week, the European Union's statistical agency is slated to release the final inflation data for the euro area for December, which will be pivotal in shaping the European Central Bank's rate decision at the end of the monthAlongside this, the anticipated annual GDP growth figures for Germany in 2024, monthly industrial production rates for November in the Eurozone, and the ZEW economic sentiment index for January in both the euro area and Germany will provide crucial insights into the latest growth status within the Eurozone.