Following a two-year cycle of raising rates to battle inflation, the Fed has pivoted attention toward rate cuts and the European Central Bank is likely to follow a similar path. This has left investors hyperfocused on predicting monetary policy moves. Markets are also trying to gauge the impact that projections for anemic economic growth in the euro area for the next couple of years will have on European equities.
But investors may look to the past for optimism. Morgan Stanley Research did a deep dive into a long history of past economic cycles and found that previous periods of U.S. soft landings and European ‘softish’ landings, particularly in the mid-1990s, offer the closest similarities to current trends and point to opportunity in European equities in the coming year.
“When you look at all the data, it’s like a time warp,” says Marina Zavolock, Morgan Stanley’s Chief European Equity Strategist. “The bottom line is we’re bullish on European equities. We anticipate a 17% gain by year-end in the MSCI Europe Index if accounting for buybacks and dividends.”
Rational Exuberance
Investors in the mid-1990s, like investors today, were in an environment in which even mixed economic data drove markets higher as bad data indicated rate cuts while good data pointed to a rebounding economy. Kicking off the soft landing playbook: in 1995 after the U.S. Federal Reserve signaled a policy pivot toward easing, European equities followed U.S. stocks sharply higher. Other evidence of a 1990s reboot include a delayed monetary policy pivot from European policymakers; concerns about deficit reduction policies in the U.S.; and a rapidly changing technology landscape.
Focusing on these parallels—along with other data, including earnings revisions, sentiment scores, company employee data and level of accounting accruals—Zavolock and her team think the sectors that look best positioned to benefit based on this historical screen are European software, aerospace and defense, semiconductors, diversified financials, pharmaceuticals and telecoms. They urge caution on luxury, chemicals, life sciences and medical technology, as well as household and personal products and food, beverage and tobacco companies.
“Earnings revisions will be an especially important indicator, and we see a trough coming this quarter with likely positive revisions into the second half of 2024,” Zavolock says. “Once central banks start cutting rates, we think funds from money markets should flow to stocks, while a much-anticipated pickup in mergers and acquisitions should further support our prediction for a rise in European equities.”
Investors will need to heed risks. For example, significant external supply shocks weren’t a big factor in the mid-1990s playbook, and today’s geopolitical risks are different than those of the mid to second half of the 1990s.
For deeper insights and analysis, ask your Morgan Stanley Representative or Financial Advisor for the full report, “European Equity Strategy: Time Warp,” (Jan. 8, 2024) and “Leaning Into the Tipping Point” (Feb. 27 2024).
