European stock investors are facing a conundrum.
On one hand, the region’s solid economic backdrop and corporate profits call for optimism and more gains before the year-end. On the other, the sea of red that has engulfed equity markets in the past week is damping the mood.
As the Stoxx Europe 600 Index heads for its fifth daily decline, the longest losing streak since May, here’s how some European investors and strategists are looking at the pull-back. While some are buying the dip, betting on a resurgence before 2017 ends, others caution that a prolonged slump may be a signal to scale down on risk.
Simon Wiersma, investment manager at ING Bank NV in Amsterdam, by phone:
Everyone was waiting for this sort of pull-back — everything was priced to perfection. It’s not surprising, but if it continues, I think it would be a signal to scale back risk rather than buy into the market. There is still a lot of uncertainty when it comes to inflation and central bank policy, both in the U.S. and Europe.
Anthony Benichou, cross-assets sales trader at Louis Capital Markets in London, in emailed comments:
European markets needed a breather, lots of “travel & arrive” post earnings, and investor appetite for risk is limited now with valuations for cyclicals not cheap anymore. Banks in particular are struggling, their ROE is still well below the weighted average cost of capital, bund yields are low, ECB still dovish, and non-performance loan issues not over yet.
There’s a liquidity problem in the U.S. credit market, and this could seriously amplify the stock market pull-back across regions. The IBEX might be a good place to hide in relative terms if the risk-off move continues. Investors will have to unwind their top picks like Nasdaq and I think they are already underweight or neutral on Spanish equities.
Guillermo Hernandez Sampere, head of trading at MPPM EK in Eppstein, Germany, by phone:
The fact that the strong performance we saw after the ECB meeting did not continue is a sign there were no new catalysts coming in; no new fundamental reasons to buy. The outperformance was exhausted. At this time of year, investors are going back to safety. It’s typical profit-taking and I don’t think it’s the beginning of something bigger. Last week, we raised our exposure to some of our German picks. We still expect higher levels before year-end.
Stephane Barbier de la Serre, strategist at Makor Capital Markets, in Geneva, in emailed comments:
Signs of over-extension had objectively been multiplying on risk assets in general and Japanese and German stocks in particular in the last few sessions. Beyond would-be fundamental excuses and other usual suspects, notably the U.S. tax reform, the newsflow has remained essentially supportive recently, which is confirmed by the fact that the traditional gauges of risk-on have remained largely sedate so far — notably the yen, gold, the Swiss franc and even volatility remains very tame, at least from a historical perspective. As long as this holds true, it’s more an overdue pull-back than an end-of-the-rally configuration in our view.
Stephane Ekolo, head of global equity strategy at Avalon Capital in London, by phone:
It is hard to call the end of the rally when one looks at the favorable trend in 4Q earnings estimates, positive global macro and potential for a U.S. tax reform deal. All these should be positive for equities going into 2018. That being said, there is nothing wrong with a pull-back, given the strong year-to-date performance, as well as we are headed toward the year-end and some window-dressing has started to occur, with market participants starting to lock gains.
Fabrice Masson, head of equities at BFT Investment Managers, by phone:
Valuation levels are a bit high, but it’s too early to say the rally is over. Nothing has changed in the past few weeks in terms of fundamentals. Investors are just looking for excuses to book some profits after what has been a pretty strong year. Some of the stocks have risen 50 percent since the start of the year. If their earnings are good, but don’t show a clear acceleration in the trend, it’s tempting to just sell.
Christopher Potts, Kepler Cheuvreux head of economics and strategy research, in a note:
Recent phase of European equities’ international outperformance is exhausted. November profit-taking marks the first stage in transition from “market climax” toward correction, and beginning of the new year is the most dangerous time. Last week marks the point at which equity markets shift from “buy-on-dips” to “sell-on-strength.”
Abi Oladimeji, Thomas Miller Investment chief investment officer, by email:
In reality, investors shouldn’t make too much of the recent soft patch. Having had such a strong rally in recent weeks and months, it’s only normal to see a bit of consolidation. Overall, looking ahead, the combination of solid growth outlook and ongoing policy support bodes well for European equities.