When Morgan Stanley’s European equity analyst team said they saw 9% upside for the MSCI Europe index in 2024, many of their clients were having none of it.
After spending recent weeks discussing its views with investors it admitted to receiving the following response: “How can you be optimistic on European equities amid such a weak growth backdrop?”
Well, in a note published Tuesday, the Morgan Stanley team gives five reasons why it is sticking to its guns. Indeed, with dividend yield and buybacks added, the total 14% upside for the MSCI Europe is possibly too conservative says the bank.
“When investors ask us the ‘biggest risk to our views’ they are surprised to find us say it is that we may not have been bullish enough. In fact, we note an attractive risk-reward for European equities with risks tilted more towards our bull case,” said Morgan Stanley. The top of its range is an MSCI Europe index gain of 23%.
The first point the bank notes is that concerns about weak European earnings growth are backward looking and also are not properly taking into account the boost provided by expected European Central Bank interest rate cuts in the second half of the year.
“Yes, Europe’s growth backdrop is weak, but every single indicator in our revamped earnings model has signaled a trough and the start to a recovery,” said Morgan Stanley, which sees 2024 earnings growth of 9% compared to consensus of 5%.
Second, the economic background will improve, particularly as lower inflation means a rise in real household incomes and thus higher consumption. In addition, recent credit survey data suggests the “worst may be behind us as credit standards are no longer tightening.”
Next, Morgan Stanley argues that anyway it is wrong to place too much emphasis on the health of the European and Chinese economies when it comes to stock market earnings. The stoic U.S. economy is more important. “Exposure to the U.S. for example sits at 25.5% on a market cap weighted basis. This is more than three times that of Europe’s market-cap weighted China revenue exposure at 7.8%,” said the bank.
Fourth, the bank thinks the market’s setup is similar to 1995 when stocks saw a re-rating of price/earnings multiples after Federal Reserve monetary policy pivots.
“Although the rerating in European equities is following the 1995 soft landing path almost exactly thus far, we assume only half of this remaining re-rating,” said Morgan Stanley. “Our base case assumes that Europe re-rates to 13.8 times next twelve month P/E by year-end versus current
levels of 13.1x.”
Again, the bank said this is conservative because following the 1995 and 2019 Fed pivots, Europe actually re-rated to a P/E of around 14.8 times.
Finally, Morgan Stanley said: “We note that European growth was similarly lackluster in the mid-1990s – but this did not stop the re-rating following the Fed pivot and as macro indicators troughed and began to recover somewhat.
U.S. investors can track the European market using a number of securities, including the iShares Core MSCI Europe ETF
which is down 1.5% for the year to date.