Investors should be prepared for more volatility and tougher times ahead.
The market can be a cruel master. That is especially true when stocks are near record highs and concerns about the economy are growing. In Europe the Stoxx 600 index is hovering close to an all-time record set earlier this year. Expectations for earnings levels remain high, even as the economic outlook weakens. There is little room for disappointment come results time.
Investors are already punishing slip-ups harshly. A cut to guidance this week at French insurer Scor sent shares down more than a quarter. Chip equipment maker ASML fell more than 10 per cent this week amid fears of a weakening outlook. Hugo Boss and Burberry have suffered similarly too. Investors have balked at unexpected, or off-strategy, dealmaking such as Carlsberg’s bid for Britvic or EssilorLuxottica’s purchase of streetwear brand Supreme. With the bulk of the Stoxx 600 set to report second-quarter earnings in the coming weeks, further bumps lie ahead.
Overly bullish earnings forecasts are not the only reason to be cautious about Europe. Politics is playing a role too. The French elections highlighted the country’s precarious fiscal position along with other markets such as Italy. That may mean lower public spending to come.
Contrast that with the US where a frenzy over the potential of artificial intelligence continues to excite market bulls. The growing likelihood of a Donald Trump presidency is boosting the medium-term outlook, with the potential for tax cuts, deregulation and higher government spending.
That combination is helping US stock markets outperform Europe. Earnings expectations reflect this divergence too. Profit margins in Europe are expected to come under some pressure as cyclical sectors such as luxury goods wilt. US margins, in contrast, are expected to continue expanding.
Even so, the outlook for European earnings may still be too optimistic. “A high bar for European earnings that are backloaded into the second half of the year means any weakness in outlook is going to be punished,” says Emmanuel Cau, equity strategist at Barclays. He sees growing volatility in the share prices of European companies as a warning sign.
An analysis of share price moves by Lex shows that volatility on European results days has been steadily rising. Announcements in the second quarter of this year elicited a share price fall of 5 per cent or greater in 4 per cent of Stoxx 600 companies that reported — the highest proportion since the final quarter of 2022.
This type of unforgiving market has in the past tended to presage or coincide with a broader European market sell-off. As the punishment for slip-ups grows, be prepared for more volatility and tougher times ahead.
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