Investors see shift in Europe’s fortunes | Popgen Tech

The mood brightened after a period of extreme pessimism about Europe, brought on by the invasion of Ukraine, a subsequent jump in energy prices and the highest inflation in decades. Russia has been the largest energy supplier to the European Union, making the region vulnerable to shocks from Western sanctions.

Market sentiment is being lifted by early signs of easing inflation in the euro zone and hopes that the scramble for alternatives to Russian natural gas has reduced the risk of an energy crisis this winter, investors and analysts said.

Meanwhile, benchmark U.S. yields and the dollar have fallen in recent weeks, helping to lift riskier assets globally as investors anticipate a slowdown in the Federal Reserve’s campaign to raise interest rates.

“We are in a repair business. There is going to be another recession. But what we’re seeing are signs that the recession won’t be as bad and that inflation may calm down faster than people thought,” said Jordan Rochester, a currency strategist at Nomura..

Foreign investors snapped up European assets. In a marker of that international appetite, flows into exchange-traded funds that hold eurozone stocks but are denominated in other currencies last month hit the highest monthly level since early 2021, Nomura analysis showed.

The annual eurozone inflation rate fell in November for the first time since mid-2021, to 10%, from 10.6% in October. A pullback in oil and other energy prices helped. Natural gas prices stabilized as Europe’s gas storage rose above 95% due to imports of liquefied natural gas, reducing the risk of an energy crisis.

Investors now expect the European Central Bank’s key policy rate to reach 2.8% next summer, market prices indicate, down from forecasts of more than 3% a month ago.

As in the US, where consumer price inflation has also eased, investors are hoping that central bankers will not have to tighten financial conditions so aggressively as to trigger a deep recession. In turn, expectations of a milder downturn and cheaper capital available for companies are boosting European stock and bond markets.

“The Fed and the ECB are winning the war on inflation, and at some point we’re going to see a break from the central banks. This is something that will drive the market higher,” says Roland Kaloyan, head of European equity strategy at Société Générale.

Some of the best performing stocks in Europe this quarter are in the industrials sector. These companies are among those hardest hit by the disruption of gas supplies and the rise in energy prices, with many companies temporarily closing factories or reducing production.

Shares in France’s Alstom SA rose 42% this quarter, while those in Siemens Energy AH

from Germany rose by 44%.

Some analysts expect other energy-intensive sectors to benefit from cheaper energy and the recent easing of Covid-19 restrictions in China, one of the EU’s biggest trading partners.

“One of the sectors in which I see a lot of upside potential in Europe is the automotive sector,” Mr. Kaloyan said.

He expects supply chain conditions to continue to improve. Europe’s major car manufacturers include Volkswagen AH

and Stellantis NV.

Conditions in the credit markets have also improved, with a decline in spreads, or the extra returns compared to a benchmark that investors demand to hold riskier bonds.

The spread on an ICE BofA index of euro-denominated bonds issued by industrial companies narrowed to 1.6 percentage points above a benchmark. This is down from 2.1 points at the end of September, but still above the average 1.1 percentage point over the past 10 years.

Some remain cautious about the region’s outlook, for example if the Russia-Ukraine war drives more volatility in energy prices and inflation.

“The rally we saw was followed by the optimistic view that the energy crisis might not be as bad as we feared,” said Antonio Cavarero, head of investments at Generali Insurance Asset Management. “But Europe is still very exposed.”

Fixes and enhancements
The surname of Roland Kaloyan, head of European equity strategy at Société Générale, was mistakenly given as Kayolan in an earlier version of this article. (Corrected on Dec. 7)

Write after Anna Hirtenstein at anna.hirtenstein@wsj.com