European equity strategists say earnings growth can push stocks 11 percent higher in 2010 following the steepest annual rally in a decade.
Goldman Sachs Group Inc. (GS) and Bank of America Corp. (BAC), which underestimated the strength of this year's gains, predict shares in the region may climb more than 20 percent over the next 12 months. Morgan Stanley is the only brokerage among 16 surveyed by Bloomberg to estimate a retreat by year-end, saying the withdrawal of government stimulus will weigh on equities.
A rally next year would extend the biggest advance since 1999 for the Dow Jones Stoxx 600 Index, the measure most commonly used by the strategists surveyed, by restoring more of the 5.5 trillion euros ($7.9 trillion) in market value that was erased after the gauge climbed to a more than six-year high in June 2007. The most bullish forecast, by Gary Baker at Bank of America, sees a 26 percent surge for the index.
"Everything is in place for a great year," said Patrick Moonen, an equity strategist at ING Investment Management, which has about $610 billion in client assets. If governments reduce stimulus, "it's a sign that the economic crisis is behind us, which is positive for earnings growth going forward."
Profits for companies in the Stoxx 600 are expected to climb 29 percent next year, according to data compiled by Bloomberg. That compares with a forecast for a 7.4 percent increase in 2009 profits. Basic-material and financial stocks are forecast to lead the earnings growth, with gains of 62 percent and 61 percent next year, respectively, the data show.
Interest RatesThe Stoxx 600 has rallied 26 percent this year and is up 58 percent from a 12-year low on March 9 as governments pledged more than $12 trillion and central banks cut interest rates to record lows to end the global recession and fix credit markets. The index increased 0.4 percent to 250.62 as of 8:14 a.m. in London today.
Global economic growth that exceeds the historical average rate next year will allow for an expansion of corporate sales, said Peter Oppenheimer of Goldman Sachs. Morgan Stanley's head of European equity strategy, Teun Draaisma, says this growth will trigger the start of a "tightening" phase, as governments raise interest rates, reversing the rally in stock markets.
Draaisma, who was top ranked by Europe-based investors in the most recent Thomson Extel survey, estimates the MSCI Europe Local Index will fall back to 1,030 by the end of the year, having rallied as high as 1,200.
Economic RecoveryIn January, Goldman Sachs' Oppenheimer said benchmark indexes would climb 20 percent by the end of 2009 if credit markets recover and the pace of economic deterioration slows. Baker's team at Merrill Lynch & Co., which was rebranded after the takeover by Bank of America, had estimated a 9.1 percent gain for this year, while Draaisma had predicted shares would make little headway in 2009.
Government reports from the U.S. to Europe and China now show economies are recovering from the first synchronized global recession since World War II. China's purchasing managers' index grew at the fastest pace in five years in November, while Europe's manufacturing industry expanded for a second month after the euro-region economy emerged from a recession.
U.S. payrolls fell by 11,000 workers last month, fewer than the most optimistic forecast among economists surveyed by Bloomberg News, Labor Department figures showed on Dec. 4.
"All of the stars are aligned on the macro settings," said Franz Wenzel, deputy director of investment strategy at Axa Investment Managers in Paris, which oversees about $600 billion. "This year-end rally can take us further." Wenzel forecasts European earnings will gain 25 to 30 percent next year, and he predicts a 15 to 20 percent increase in stocks globally.
Profit GrowthProfit growth may help lift European stocks as much as 19 percent by the end of 2010, according to the London-based head of European equity strategy at JPMorgan Chase & Co., Mislav Matejka. He estimates the MSCI Europe Index may reach 1,300 by the end of next year.
"The near-term catalysts are a strong earnings reporting season, positive payrolls, rebound in leading indicators and increasing risk allocation into the new year," Matejka wrote in a report dated Dec. 8.
Morgan Stanley's Draaisma says the withdrawal of government stimulus measures will spark a "very dangerous period" and equities will suffer. He said the MSCI Europe Local Index would rise 1.5 percent to 925 in 2009, data compiled by Bloomberg show.
'More Difficult'The European Central Bank said financial markets have improved sufficiently to allow it to rein in some of its emergency liquidity measures as the euro region recovers gradually from the recession, according to its monthly editorial bulletin on Dec. 10. Economists expect the Frankfurt-based central bank to increase borrowing costs in the third quarter of 2010, according to a Bloomberg News survey.
"The major event next year will be the moment when an increase in interest rates takes place," said Christian Dargnat, chief investment officer at BNP Paribas Investment Partners in Paris. "The second quarter will be more difficult, more volatile as investors anticipate the increase." Including assets from BNP Paribas SA's purchase of Fortis, BNP Paribas Investment Partners oversees about $769 billion.
Basic-resource shares have led gains in Europe this year, rebounding from the worst performance among the 19 industry groups in the Stoxx 600 in 2008. Dargnat is keeping an "overweight" stance on the industry, which means he's holding a greater proportion of the stocks than are represented in his benchmark, as he believes the companies are benefiting from improvements in the economy.
Worst PerformersBank of America's Baker says investors will miss out buying so-called defensive shares, such as health-care and utilities companies, whose earnings are less tied to economic growth, and recommends "underweight" positions in these sectors. Utilities in the Stoxx 600 have been the worst performers of 19 industries this year.
Banks and basic-resources have surged 45 percent and 93 percent this year, respectively, beating all other sectors, as money managers favored buying some of the most beaten-down industries after the 2007 peak.
An 11 percent gain in the Stoxx 600 forecast by the strategists would leave the index at 277, from yesterday's close of 249.57, compared with its 2007 peak of 400.31. The index plunged 61 percent from the high through March this year amid subprime mortgage-related losses at banks that now total $1.71 trillion and the credit crisis that followed the September 2008 collapse of New York-based Lehman Brothers Holdings Inc.
'Powerful Driver'The money spent or lent by government and central banks to revive financial markets that has contributed to gains in equity markets this year will remain a "powerful driver" for stocks in 2010, according to strategists Graham Bishop and Ian Richards at Royal Bank of Scotland Group Plc in London. Morgan Stanley's Draaisma says the withdrawal of stimulus funding in the second half of 2010 will drag equities lower.
"A lot of scenarios depend on the macro environment and how policy makers react," said Gerhard Schwarz, strategist at UniCredit SpA's German unit in Munich. "Our message is stay with the market now. We haven't seen the peak yet."