Equity View: Unwind Short European Equity Index Positions

Summary

• We are unwinding our European equity index short positions.
• They have outperformed the S&P 500 (SPX) since inception as Europe has countered the adverse impacts of the Ukraine war and high prices more successfully than we expected.
• Eurozone economists now project a winter recession will be milder than expected, suggesting European equities may continue to outperform SPX.

For the full overview of our equity insights, please see the latest Equity Trades report.

EU Equities Have Been Resilient

We are unwinding our short European index trades – specifically Euro Stoxx 600 (SXXP), Euro Stoxx 50 (SX5E) and FTSE 100 (UKX), all versus a long S&P 500 (SPX) leg.

We entered these trades on 28 July 2022 expecting European equities to underperform given the ongoing economic pressures of the Ukraine war and rising recession risks. We noted then that earnings expectations remained high and that, as analysts cut their forecasts, European equities would fall further.

So far that has not happened. Rather, European equities have performed roughly in line with or better than the SPX (Chart 1; Table 2). The European economy and equities have been more resilient than we expected, and markets had probably already priced in a lot of bad news. (The SPX has outperformed European equities on a currency-adjusted basis, but we account for FX effects; our focus is local currency performance.)

Eurozone economists now project that a European recession this winter will likely be less severe than previous forecasts. They now expect a decline in GDP of -0.5% in 4Q 2022 and ­-­0.1% in 1Q 2003. Previously, economists expected GDP to be down -2.1% during the first three quarters of 2003. A key reason is a decline in gas prices and gas consumption due to conservation efforts and a mild autumn.

There is good reason to doubt this forecast. Temperatures could drop suddenly and remain persistently low. Russian actions are unpredictable, both against Ukraine and Western Europe – but you would be wise to err on the side of caution. And the ECB is in inflation-fighting mode, putting upward pressure on rates.

Still, there is little question that severe recession risks have receded. For now, we expect the European equity markets to perform in line with or better than the SPX.

Appendix

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)