European Stock Strategists Double Down on Gloom After Brexit

The Case for Equities Amid Geopolitical Uncertainty

Stock forecasters at European banks are resigning themselves to the prospect of steep losses for the region’s equities in 2016.

Strategists who kept predictions practically untouched in the weeks leading up to the Brexit vote have just turned the most bearish in 10 months. They estimate the Euro Stoxx 50 Index will end the year just a little above where it was at last close, implying an annual decline of 9.2 percent, compared with June calls for a 3.3 percent drop. That amounts to the steepest cut in monthly predictions since October.

While stocks slumped after the Brexit vote, forecasters slashed projections even faster, signaling little room for a rebound in the rest of the year. The fallout from the U.K.’s vote to leave the European Union is the latest in a string of threats plaguing euro-area equities. Concerns over slowing economic growth and the strength of the banking sector, especially in Italy, have dragged the Euro Stoxx 50 lower in the first two quarters even as the European Central Bank kept up unprecedented stimulus measures.

“Brexit was the straw that broke the camel’s back,” said Michael Hewson, a market analyst at CMC Markets in London. “People are now focusing on the next domino -- and the next domino is Italy. Europe’s problems start and finish with the health of the banking sector -- it’s not just the elephant in the room, it’s the elephant, rhinoceros and T. Rex rolled into one.”

Fears about lenders’ stability and Italy’s bad loans come after last month’s shock British secession vote sent stocks around the world tumbling. Even as global shares have recovered, the Euro Stoxx 50 remains 3.7 percent below its level on the day of the referendum. Strategists, who like investors had failed to factor in the scenario before the vote, are now scrambling to catch up.

Their outlook for the Euro Stoxx 50 has worsened since the start of the year, when they forecast gains of more than 10 percent. On average, they now project the gauge will end the year at a level of 2,967. While that’s 1.4 percent above yesterday’s close, it would represent the first annual drop since the gauge tumbled 17 percent in 2011. The index climbed 1.4 percent at 11:08 a.m. in London.

“Look at the underlying dynamic, the underlying momentum -- it’s been pointing down pretty remorselessly all year,” said Michael Ingram, a market strategist at BGC Partners in London. “Growth remains feeble, corporate warnings have trodden water for years, banks are fragile, and the authority of monetary authorities is rapidly eroding. There are just so many threads to this.”

Lenders, already the worst-hit equities among industry groups this year, are forecast to post a profit decline of 17 percent this year, versus a 4 percent drop for the broader Stoxx Europe 600 Index, data compiled by Bloomberg show. Italy is trying to shore up a banking system saddled with bad loans without breaching EU rules while Prime Minister Matteo Renzi plans to hold a referendum to overhaul the political system this fall.

Some investors see opportunity in Europe’s stock slump. JP Morgan Asset Management and Pictet Asset Management have called the equities a buy, citing low valuations relative to U.S. shares. The firms also hold an overweight rating on U.K. stocks after the vote, saying a weak pound will continue to support the FTSE 100 Index’s large caps. The British gauge entered a bull market this week, while the Stoxx 600 traded near its highest level since the referendum.

But while some of the concern about the fallout from Brexit has eased amid central-bank reassurances of looser monetary policy and the appointment of a new prime minister in Britain, it may not be enough to woo investors to euro-area shares. The region’s equity funds have seen 22 straight weeks of outflows, the longest streak since 2008.

“When there is uncertainty about what’s going on, in this case Brexit, the best thing to do in order to keep your job is to cut your estimates,” according to Ben Kumar, who helps oversee about 10 billion pounds ($13 billion) as investment manager at Seven Investment Management in London.

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