European equities: risk-reward to the downside

Global and regional macro backdrop is improving, investor sentiment is getting more bullish, EPS have turned the corner and are now on a more positive trend… No surprise European equities finished 2016 in a pretty better shape than they started it. Is the rally going to continue in 2017 ? Well, the mood is there and some brokers have decided to add some fuel to it.

This morning, Deutsche Bank and Merrill Lynch raised their SXXP y/e target to respectively 375 (from 345) and 390 (7% upside). Drivers for upside: accelerating growth, higher earnings revisions and EPS growth (11% for 2017e vs 7-8% previously at Merrill), forward P/E of 15x (stable from current level).

Better macro backdrop…

Source: Deutsche Bank

Source: Deutsche Bank

… and better earnings/valuation sentiment

Source: Bank of America Merrill Lynch

Source: Bank of America Merrill Lynch

Source: Deutsche Bank

Source: Deutsche Bank

Some words of caution though

Everything looks rosy but it could also turn the other way around… As many times in the past, markets have already priced in many of the good news they think will materialize over the coming quarters. That’s mainly what’s behing the Trump election and how markets reacted positively to it.

If the two brokers are turning more bullish, they underlying the fact that the current risk/reward for European equities looks biased to the downside.

“The upside risk to our scenario is an even-stronger-than-expected rebound in global growth against the backdrop of falling macro uncertainty and additional euro weakness. In that scenario, the Stoxx 600 could reach 410 (12% upside from current levels). On the downside, there is a risk that Trump’s policies turn out to be less market-friendly than expected, rising rates start to damage the valuation case for equities and a strong USD puts renewed pressure on commodity prices. Under these circumstances, the Stoxx 600 could sink back to 315 (14% downside).”

According to Merrill Lynch,

“European equity markets have entered a bull market, rallying 20% from the lows of last year and investors are lining up to expect a better year of growth in 2017. We agree growth is accelerating but are relatively cautious on how much upside that gives equity markets.”

A good question indeed, but as we know, markets can go up for quite some time before they realize it was based on pure speculation rather than actual fundamental changes in GDP growth or corporate earnings dynamic.

 

 

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