The economic weakness in the Eurozone continued in the third quarter. While there are now signs of a bottoming out in terms of sentiment in the industrial sector, service providers have recently been showing signs of weakness as the post-pandemic economic recovery fades. This makes the development of yields in Europe all the more surprising; for example, the yield on Austrian 10-year government bonds briefly exceeded the 3.5% mark. The fundamental economic data in Europe does not justify this development at all; it seems rather that the European bond market got carried away by the pull of the strong US data with a surprisingly robust economic development and the corresponding reaction of the bond market.
After the ECB's tenth interest rate hike and record interest rates of 4.5% since the introduction of the euro, the end of the line now appears to have been reached. If the ECB's Governing Council is followed, the current interest rate level - if maintained long enough - should make a significant contribution to achieving the inflation target. Meanwhile, inflation is actually falling; after the energy components, food is now following suit, and service prices should also weaken due to the economic cycle, so a decline in core inflation is observable.
This combination of high yields and a slowing economy is naturally not very helpful for the stock markets; the Stoxx 600 lost 1.7% in the month of September, with the performances of the sub-indices varying greatly. The oil and gas sector, for example, topped the list with a gain of 5.3%, supported by rising oil prices. Basic resources also performed strongly with a 5.0% increase, which can also be interpreted as a technical countermovement to the massive price losses in January-August. Banks were also among the winners, continuing their successful run and gaining a further 2.6%. YTD, the price gain is now already 15%, topped only by the retail sector, which has shown price gains of 23% after the first nine months of this year. Losers included utility stocks (-4.3%), technology (-5.7%), and travel and leisure (-5.9%).
In terms of valuation, the Stoxx 600 is currently trading at a price-to-earnings ratio of 12.7x, which appears cheap (from the historical perspective) for now; the average over the last 10 years is just under 15.8x. As a result of the rise in yields on 10-year government bonds, which usually serve as a reference for the risk-free interest rate, the implied risk premium for the Stoxx 600 has fallen sharply and, at 4.4%, is at the lower end of the range for the last 10 years. Seen in this light, the European benchmark index currently appears to be rather highly valued. Earnings estimates have recently tended to be adjusted upwards, and earnings are also expected to rise in the coming years, around 9.3% for 2023 and a further 9.1% for 2024, which should have a supportive effect on the further price trend. The strongest earnings momentum is currently seen in the banking sector, the weakest in basic materials stocks, which is also reflected in the aforementioned share price developments since the beginning of the year.
We are not overly optimistic about the share price performance for the fourth quarter; we expect a low single-digit increase. The negative sentiment will only brighten slowly. Hope is provided by the inventory cycle in industry, which should provide impetus again at some point, and the real income situation of households, which should result in rising demand following high wage settlements and declining inflation.
Author:
Christoph Schultes, CIIA®
Chief Analyst CEE Equity
Erste Group Bank AG
3 October 2023
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Note
Wiener Börse AG would explicitly like to point out that the data and calculations given in this report are historic values, which do not permit any conclusions as regards future developments or value stability. Price fluctuations and loss of capital are possible in securities trading. The contribution is the personal opinion of the analyst and does not constitute a financial analysis or a recommendation for investment by the exchange operating company, Wiener Börse AG.