Home| Technology| About| Customer Support| Login
Gallery inside!
Markets

Europe's Energy Shortage Could Lead to a Credit Crunch

European stocks have had a remarkable run, but they may be due for a breather.

January 24, 2023
2 minutes
minute read

European stocks have had a remarkable run, but they may be due for a breather.

On Tuesday, the eurozone composite Purchasing Managers Index (PMI) rose to 50.2 in January, up from 49.3 in December. The PMI is a closely watched index that tracks business activity across both manufacturing and services. A reading above 50 indicates growth, while a reading below 50 indicates contraction. The latest reading implies that the core of the European economy has returned to growth this year, albeit only marginally, after a six-month downturn.

Although the news is good, it may not be enough to justify the current level of optimism toward European stocks.

The Stoxx Europe 600 index, which tracks the region's largest stocks, has risen by 24% over the past three months. This is compared to the 6% rise of the S&P 500. Both stocks and the euro have been strong, which is not a common occurrence. According to a monthly survey by Bank of America, more fund managers have positioned their portfolios favorably toward European stocks than at any point since Russia invaded Ukraine in February last year.

Investors have been cheered by a confluence of good news: A mild winter has eased the energy crisis resulting from the war in Ukraine, while China’s shift away from its previous zero-Covid policy has raised hopes of stronger global growth. Whether China’s reopening turns out to be messy or orderly will be a key swing factor for the performance of important European sectors such as autos and luxury this year. European companies are on balance more exposed to the Chinese market than American ones, so the outcome of this situation will be crucial for their fortunes in 2021.

An even bigger factor could be the delayed impact of last year's interest-rate increases on the real economy. For Sebastian Raedler, an investment strategist at Bank of America, "the sharpest monetary tightening in 40 years" is the real drag on Europe's economy right now, not the receding energy shock. Surveys suggest European credit conditions are already deteriorating.

European Central Bank President Christine Lagarde has said that she plans to raise interest rates further in order to bring down inflation. Last week, she reiterated this plan in a speech given in Davos, Switzerland, and again on Monday in Eschborn, Germany.

The main factor driving markets last year was the valuation headwind from rising real rates. This actually helped European indexes relative to the S&P 500, as they have fewer of the highly valued growth stocks that are most sensitive to rates and more cyclical stocks. Britain’s FTSE 100 index, which has more than its fair share of the commodity stocks that bucked the wider trend, even came close to hitting record highs this month.

The likely effect of rising interest rates on corporate earnings is still to come. In the U.K., which started raising rates earlier than the eurozone, the economy is already weakening. The country's composite PMI reading for January, released on Tuesday, came in at 47.8, a 24-month low. The cyclical bias of European companies will prove a weakness in a downturn. Moreover, if the Federal Reserve reacts to bad economic news by cutting rates, it would give U.S. growth stocks a fresh tailwind at the expense of European cyclicals.

The European economy appears to be caught between last year's energy crisis and a potential credit crunch. This relative calm provides a good opportunity to take profits off the table.

Tags:
Author
John Liu
Contributor
Eric Ng
Contributor
John Liu
Contributor
Editorial Board
Contributor
Bryan Curtis
Contributor
Adan Harris
Managing Editor
Cathy Hills
Associate Editor

Subscribe to our newsletter!

As a leading independent research provider, TradeAlgo keeps you connected from anywhere.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Explore
Related posts.