European Markets Face Challenges Ahead

By Naomi Rovnick

LONDON (Reuters) – The year ahead is shaping up badly for Europe with its financial markets already hit hard by U.S. tariff fears and political turmoil in France and Germany. Yet some investors are calling peak pessimism and hunting for bargains amid the gloom.

European stocks are set to underperform the U.S. by the most in at least 25 years, MSCI data showed, while the euro has slumped more than 5% against the dollar. Some forecasters expect sustained bad news to drag it below $1.

However, as the region's markets get cheaper, investors are increasingly interested in hunting for bargains, arguing that assets are fully priced for more disappointment and could rally strongly if the geopolitical and economic backdrop brightens.

> "We believe Europe could be a positive surprise for underexposed investors," said Edmond de Rothschild co-head of equities Caroline Gauthier. "We are close to reaching a peak in negativity and that is good news."

A broad MSCI index of continental European stocks has gained 4.6% this year, while a comparable U.S. index surged 29%, driven by significant gains in technology stocks.

"Valuation levels in Europe are (now) far more attractive," said Sonja Laud, CIO of Britain's largest asset manager, Legal & General Investment Management. However, she added that they were not yet broadly raising exposure to Europe, but warming to sectors like car makers and luxury goods.

Euro zone productivity is weak, and the European Central Bank has downgraded its growth forecasts alongside its fourth rate cut of the year. Cautious households are hanging onto their savings.

In a sign that traders see extreme market pricing, German stocks have started to soar. Germany's DAX index is up 4% so far in December and is set for its best month since March.

Europe’s largest asset manager, Amundi, forecasts strong gains for the euro next year, while other major European investors are starting to show interest in beaten-down French stocks.

Germany is expected to hold snap elections in February after Olaf Scholz's coalition collapsed. While top contender Friedrich Merz backs stimulus spending, this will require strong cross-party unity.

> "We're trying to make the most of the pessimism we see in Europe," said Kevin Thozet, member of the investment committee at Carmignac, adding he was building positions in European multinationals that trade on lower valuations.

Euro zone economic trends remain grim. Citi's economic surprise index for the bloc indicates that widespread data misses expectations. However, it has stopped falling sharply, indicating that severe negative data shocks for markets have reduced.

> "Bearish positioning (in Europe) has reached extremes," Citi strategists said on Dec. 10, recommending clients buy into the region as monetary and government stimulus would benefit cyclical businesses in manufacturing and travel.

Columbia Threadneedle chief European economist Steven Bell noted that European assets are cheap "for good reasons" but also mentioned looking for opportunities among undervalued French stocks that could rebound if budget stresses lessen.

Wall Street Bubble?

Bank of America strategist Michael Hartnett warns that potential U.S. tariffs could push U.S. inflation and interest rates higher by spring 2025, triggering a rush of investment into "cheap" international alternatives to U.S. stocks. U.S. equity markets heavily depend on large tech stocks, exposing them to concentration risk.

Hartnett predicts a "major correction" in U.S. stocks in the first half of 2025 and expects more investment to flow toward European companies as a result.

($1 = 0.7920 pounds)