Europe’s Bear Market Just Getting Started

By Michael Msika, Bloomberg markets live reporter and analyst

The surge in inflation, the jump in yields, the energy crisis, the revival of political risks in Italy, and now the pound meltdown. If you thought things were bad enough for European stocks, try looking at the technical picture.

The Stoxx 600 Index joined US and regional peers in a bear market on Friday, and those who keep an eye on long-term charts warn the gloom is unlikely to lift any time soon.

Crucially, the benchmark has broken below the key 400 points level, a source of major resistance dating back two decades. That may cast doubt on any attempt to rally after the gauge slipped into oversold territory, typically an indicator of an imminent bounce.

Also consider that the market is yet to show any big signs of stress that would point toward an imminent turnaround. Only about 20% of Stoxx 600 constituents are oversold, far from the levels seen during downturns of the past two decades.

Similar comments apply to the Euro Stoxx 50 index, which last week broke below key support at 3,490 and closed below July 5’s intraday low, a possible indicator of more downside. The gauge is about 22% above its long-term trend line since 1987, according to Aurel cross-asset salesperson Gurmit Kapoor, who says things could get “very bad.”

DayByDay technical analyst Valerie Gastaldy has downside targets of 3,100 for the Euro Stoxx 50 and 365 for the Stoxx 600, but says the current ultra-bearish sentiment may act as a cushion on the way. “Usually, such a high level of pessimism doesn’t turn into a crash,” she says.

Strategists aren’t much cheerier, with investor confidence in the European economy having plunged to levels seen during the pandemic, the sovereign debt crisis and the global financial crisis. That’s yet to be fully reflected in stock prices, a major dislocation with history.

Bank of America’s Sebastian Raedler is underweight European equities, even though his year-end target for the Stoxx 600 implies no further downside.

At Barclays, strategists led by Emmanuel Cau say tighter-for-longer financial conditions and the Federal Reserve’s tolerance for economic pain as a condition for cooling inflation “do not bode well for equities.”

The precondition for equities to start a new bull market — a Fed rate cut — hasn’t been met yet, they say, maintaining a defensive allocation.