The European stock markets experienced a significant surge on Tuesday following Deutsche Bank's advice to close its hedge on equity exposure and adopt an overweight position in stocks.
The Europe-wide Stoxx 600 index XX:SXXP soared by 1.6%, with hopes that the Federal Reserve might put a halt to its cycle of interest rate hikes serving as a major driving force for this positive trend.
Resource groups listed in London and German auto and engineering companies, sensitive to developments in China, led the rally. The market sentiment was further boosted by reports suggesting that Beijing was contemplating an increase in its budget deficit to initiate a fresh stimulus for the world's second-largest economy.
Maximilian Uleer, the head of European equity and cross-asset strategy at Deutsche Bank, believes that further gains are highly likely. In a new note prepared in collaboration with colleague Carolin Raab, Uleer asserts that the risks that have been burdening equity markets in the third quarter are now transforming into lucrative opportunities.
One key factor contributing to this positive outlook is the improvement in the economic environment. Recent eurozone purchasing manager surveys, which had been on a sluggish decline for five consecutive months, have finally reversed course and shown signs of improvement. Additionally, Uleer notes that the softer growth in China has already been factored into the equation. Furthermore, even though a mild recession in the United States is widely anticipated by the market, it is expected to have only a limited impact on the overall performance.
With these factors at play, the future appears promising for the European bourses as they continue their upward trajectory.
Monetary Policy Trajectory and Market Expectations
According to Uleer, the monetary policy trajectory may now be more supportive, leading to positive surprises from central banks next year. This expectation is based on the recent movement in implied rates, with higher rates followed by later cuts. Historical data shows that after the last rate hike, German bund yields fell by more than 100 basis points within 12 months in 9 out of 10 cases.
In addition to the potential supportive monetary policy, earnings expectations are currently on the negative side. After significant downward revisions, forecasts now appear to be more realistic for this year. However, consensus growth projections of just 3% for 2024 may be too negative. Uleer anticipates a higher earnings growth rate of 5% for next year.
Given these factors, Deutsche Bank expects stock markets to recover in the fourth quarter. Their forecasts for 2024 include a Stoxx 600 index level of 510, the Euro Stoxx 50 at 4,850, and the DAX index at 18,000.
Uleer previously expressed caution towards equities in July and recommended hedging by buying 3-month at-the-money put options on the Euro Stoxx 50. This particular position would have tripled in value. However, Uleer now advises traders to close that position as it expires soon and suggests going overweight into stocks.
Overall, Deutsche Bank prefers equities over fixed income investments. They believe that taking risk through an overweight position in equities is favorable from a multi-asset perspective. However, when it comes to fixed income, they prefer purchasing long-duration government bonds with high ratings instead of credit. This preference is due to the expected decrease in rates and an anticipated negative correlation between government bonds with high ratings and equities.