(Bloomberg) — A year after Vladimir Putin invaded Ukraine, the rally in European stocks still threatens to escalate the war.
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While the region’s stocks have recovered from the drop immediately following the Russian attack, they are now more vulnerable to sharp shocks following a nearly 8% rally this year. If the war gets worse, it will not only cause geopolitical instability in Europe, but also put pressure on energy and food prices, increase economic gloom and affect profits. profits of companies.
“It is clear that the market views risk as lower than at the start of the war and while the elements of the recovery are understandable,” said Sophie Lund-Yates, lead equity analyst at , the margin of safety for European equities has now eroded.” Hargreaves Lansdown. “That means any unexpected escalation or volatility is likely to lead to a strong market reaction.”
Europe’s main equity benchmark rallied in 2023 as signs of cooling inflation and better-than-expected earnings boost economic optimism. But war isn’t far from investors’ minds, with fund managers in a Bank of America Corp survey. has cited worsening geopolitical concerns as the second-biggest threat to markets, after persistent inflation. Most do not expect a peace treaty this year.
The polarization between winners and losers in equities, coupled with a weaker euro, suggests not all risks have been priced in, said Barclays Plc strategist Emmanuel Cau. European energy shares have rallied 20% over the past year as Russia cut natural gas supplies in response to sanctions, while shares of real estate companies are sensitive to interest rates. fell 29%. The euro has recovered most of its losses through September, but remains well below pre-war levels.
Read more: The war hits the one-year mark with no end
Recent developments suggest that the possibility of escalation cannot be ruled out. Support for Putin’s war has grown domestically, even as casualties soar. And Moscow suspended the nuclear treaty with the US, a move President Joe Biden called a “major mistake”, although he said he did not believe it signaled the Russian leader would use nuclear weapons. core.
energy crisis
A potential energy crisis is one of the major risks from war. While a mild winter helped Europe avert this crisis, stocks could fall again if the war drags on into the colder months. Another jump in energy costs will also further reduce the company’s profit margins.
“The need to replace historically cheap energy sources will remain a challenge,” said Charlotte Ryland, co-chief investment officer at CCLA. She does not see oil and gas company profits rebounding this year as commodity prices fall back from historic highs.
With war forcing governments to shift long-term investments, spending on renewable energy and defense companies could be boosted. Strategists at UBS Global Wealth Management say they see opportunity in areas including commodities, green technology, energy efficiency and cybersecurity.
“Even if the war ends, we will be more reluctant to use Russian supplies because it is not a reliable source,” said Joost van Leenders, senior investment strategist at Van Lanschot Kempen. dependable, so the energy and chemical industries are bound to innovate.” . “Promoting renewables is the only way Europe can become more independent.”
Food cost
Another sector likely to be hit hard if the conflict continues is food and drink, where supplies of some items have been disrupted over the past year.
Bloomberg Intelligence strategists Tim Craighead and Laurent Douillet said food industry profitability “faces a potential long-term challenge” as Ukraine’s key supplies of sunflower, oil, corn and wheat shrink limit increases in prices.
Higher costs will add to price pressures already hurting consumers and making central banks belligerent.
The Berenberg economists wrote in a note that rising food and energy prices leave consumers with less money to spend elsewhere, while increasing costs for businesses, leading to increases growth was much weaker and inflation was much higher than expected before the war. As a result, they expect real GDP in 2024 to be 3.6% lower and a price level 8.9% higher than would otherwise be.
Cyclic risk
Economically sensitive sectors risk reversing their outperformance against so-called defensive states if war escalates. The cycles were thwarted early last year as investors factored in the impact of the invasion on economic growth. Over the past few months, however, such stocks have beaten relatively safer stocks.
Overall, the outlook for European stocks is becoming more dimmer after the rally. Strategists in a Bloomberg poll expect the Stoxx 600 to end the year below current levels as economic momentum deteriorates.
Investors have poured $40 billion into global equity funds since the war began, a fraction of the $354 billion that has gone into cash, according to a Bank of America report cited by Reuters. EPFR Global guide. And recently, they’ve been dumping bond prices as they’ve positioned interest rates higher for longer in the US.
Beata Manthey, head of European equity strategy at Citigroup Inc., expects geopolitical risks to hamper European equity valuation as gasoline prices fall, the dollar weakens and China’s reopening is now priced in.
“As for the protest, we’re not going to pursue it from here,” she said.
–With support from Michael Msika.
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