European stocks may drop as much as 10% over the next few months.
That’s the view of Morgan Stanley strategists led by Graham Secker, who expect the MSCI Europe Local Index to slump over the summer as economic growth slows and market liquidity shrinks, before rebounding again toward the end of the year.
“Year-to-date equity resilience is likely to become increasingly challenged over the next three months as economic momentum disappoints and liquidity conditions tighten further,” Secker wrote in a note dated June 4. “We see cracks emerging.”
The strategist — who earlier this year correctly predicted the outperformance of European stocks versus the US — said global economic growth will likely slow materially over the next couple of quarters, while European stocks will also have to contend with a stronger US dollar, ongoing monetary tightening and liquidity issues.
Shrinking liquidity is expected as the US Treasury sells bonds to refill its coffers after the debt-ceiling deal — with other strategists also predicting a big hit to equity markets as bank deposits are raided to pay for the new T-Bills.
After surging almost 10% this year through the end of April, European stocks faltered in May amid worries about sticky inflation and a potential recession. The region also underperformed the S&P 500 by the most since 2010 in dollar terms as the US benchmark — which includes more technology stocks — was boosted by a rally in artificial intelligence-related companies.
Secker is still positive on European stocks in the longer term. He expects the summer slump to be followed by a rebound as Europe benefits from cheaper valuations and more resilient earnings trends than the US. The strategist expects the MSCI Europe Local index to end the year at 1,970 points, implying almost 6% upside from Friday’s close.
In the note, Secker also downgraded European banks and insurers to neutral from overweight, saying the sector will struggle to outperform during an economic downturn and the end of the rate-hiking cycle. He upgraded pharmaceuticals stocks to overweight and food retail stocks to neutral to reflect a more defensive stance for the next few months.
