By Lucy Raitano and Julien Ponthus
LONDON (Reuters) – Hit by surging inflation and Russian invasion of Ukraine, European shares have sunk to their lowest level in a year on March 7, falling over a fifth from their January highs to end up in what investors consider a bear market.
Funds have dumped a record $20 billion of European equities in the past two weeks, including $13.5 billion just last week, according to data from funds tracker EPFR, backing out of what at the start of the year appeared to be one of leading bets for 2022.
But strategists and portfolio managers say market reaction had far exceeded the scale by which 2022 earnings forecasts have been trimmed and see as overblown fears of economic stagnation and high inflation, or “stagflation”, gripping Europe.
For now, they just expect slower growth than earlier anticipated.
On Wednesday, the pan-European STOXX 600 index returned to where it opened at on Feb. 24 when Russian troops entered Ukraine, a sign that bets on Europe Inc were still on.
“We kind of agree with the ‘flation’ side of the stagflation but not the ‘stag'”, said Nick Nelson, head of Global & European Equity Strategy at Swiss bank UBS.
His team has almost halved its 2022 growth expectations for European earnings to 8% from the previous 15%, but does not see a worst case materialising at the moment and UBS says European shares have room to gain 7%.
Europe has been hit by the conflict the hardest because of its proximity and close business ties to the area. Russia accounts for 2-4% of sales for many leading European companies and is also a key supplier of natural gas.
Data from Refinitiv I/B/E/S shows a spike in downward revisions of earnings forecasts for STOXX 600 companies, with outlook cuts now accounting for over 60% of all revisions.
Negative tweaks to expectations now constitute over 60% of total revisions.
While outright stagflation is considered unlikely, some like Jerome Schupp, fund manager at Prime Partners are factoring in slower economic growth and his firm has already diversified outside the financial and cyclical sectors.
But the outlook for profit growth is still upbeat with earnings seen rising during the four quarters of 2022 by 21.5%, 8.4%, 13% and 7.6% respectively, according to Refintiv I/B/E/S estimates.
While European Central Bank cut its 2022 growth target from 4.2% to 3.7% to reflect the war’s impact, it would leave the euro zone still with a growth rate far exceeding how it performed on average over the past 20 years.
“Euro zone growth is still trending above trend,” said Emmanuel Cau, head of the European equity strategy at Barclays, adding that stock markets probably over-reacted.
His team cut its 2022 profit growth forecast for Europe to 8% from 14% but does not see a repeat of the oil shocks of the 1970s which triggered deep recessions.
JP Morgan strategists also see a decline in earnings as unlikely unless economic growth slows below 1%, well below the 3.2% rate now expected by their economists.
Kasper Elmgreen, Head of Equities at French asset manager Amundi, said that while the recent sell-off hit European stocks across the board, companies’ pricing power and ability to preserve margins will be key for their performance.
“If you are a company and your prices are very sticky, you don’t have ability to move them a lot, then wages go up 5-10%, and raw material prices go up, your earnings may disappear,” Elmgreen said.
“If you run a business with pricing power, like luxury or pharma, the customer is willing to pay that, and earnings will be more stable.”
(Reporting by Lucy Raitano, Julien Ponthus and Danilo Masoni in MILAN; Editing by Saikat Chatterjee and Tomasz Janowski)
