(Bloomberg) — War, an energy-starved winter, a coming recession that could outlast any American. Oh, and a new ECB hawk. How Europe will overcome its mountain of problems is anyone’s guess — and investors aren’t dying to know.
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Money managers pulled $3.4 billion from European markets in the week to Sept. 7, bringing total outflows over the past six months to $83 billion, Deutsche Bank AG said, citing data from EPFR Global. Among those who fled are BlackRock Inc. and the region’s largest asset manager Amundi SA. Analysts at Bank of America Corp. and JPMorgan Chase & Co cut year-end forecasts for the Stoxx 600 and Euro Stoxx 50 respectively.
Europe’s woes have grown particularly acute in recent months as the region stares down the threat of a recession as its central bank mounts an aggressive campaign to tame inflation. Russia’s rigging of gas supplies to the West is exacerbating an energy crisis that could lead to a rationing this winter.
Already, it is forcing strapped governments, some with debt-to-GDP ratios of around 150%, to dig deeper into coffers for hundreds of billions to pay for the proposed price caps. Meanwhile, the common currency is falling to lows against the dollar not seen in two decades.
“We’ve been expecting a recession in Europe for months, given the energy crisis, but we don’t think stocks have fully priced that in,” said Wei Li, BlackRock’s London-based head of international investment strategy.
Indeed, Europe’s main stock index is down just 14% in 2022, outperforming the US benchmark and the MSCI World Index as it reaps the benefits of a weak currency making exports more competitive and a resilient second-quarter earnings season.
But as the continent faces what Finland has described as a “Lehman Brothers energy industry” moment, warnings that a complete shutdown of Russian gas would plunge the region into recession are growing louder. Economists’ forecasts of a recession in the eurozone next year rose every month in 2022, with the odds reaching 60% in August, according to 11 respondents.
Read more: All eyes on Ukraine as Russia tightens grip on Europe
Strategists at Citigroup Inc. expect a flurry of downgrades in the coming months, while the likes of Morgan Stanley warn that margins are facing their biggest drop in more than a decade.
A looming economic slowdown will disproportionately hit European stocks, even as high inflation lowers potential bond yields, according to Bank of America strategist Milla Savova, whose team further cut one of its most pessimistic targets for the Stoxx 600 in August.
Germany, with its high exposure to natural gas shortages and cyclical industries, has become a favorite target for short sellers. One- to three-month DAX options with strikes 10% below current levels are trading near their highest level this year compared with similar options on the Euro Stoxx 50.
And they are also betting heavily on bonds, which would normally be used to hedge against a recession. Investors have been steadily accumulating short positions in German bonds as yields hover near their highest level in a decade. The European Central Bank raised interest rates by 75 basis points on Thursday and promised “several” further hikes for the 19-nation eurozone.
Overall, the situation for financial assets in Europe looks gloomier than elsewhere in the world. Outflows from Europe-focused ETFs are the biggest in at least 15 years, while regions such as the U.S. have continued to attract inflows, according to data compiled by Bloomberg. Money managers have added $166 billion to global stock markets this year, according to Deutsche Bank.
That contrasts with the last time money flowed out of Europe at a similar rate, in the six months to June 2019, when investors pulled $80 billion from European stocks, but almost $200 billion also retreated from global stocks.
“The decoupling mirrors the Russia-Ukraine conflict given its disproportionate direct impact on Europe,” said Parag Thatte, Deutsche Bank strategist.
Europe’s markets have even lost faith in some of its stalwarts. Amundi, which manages about 2 trillion euros ($2 trillion) in assets, became the latest to say it was time to reduce equity exposure and turn more defensive, especially when it comes to European shares.
“There are relative value opportunities that favor the US over Europe,” said Amundi deputy CIO Matteo Germano. “Europe is more exposed to a disinflationary shock exacerbated by geopolitical tensions and the region’s dependence on Russian energy imports.”
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