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By Clayton Browne

Morgan Stanley Research published a new European Equity Strategy report focusing on opportunities in European banks on Monday, July 14th. MS analysts Graham Secker and colleagues offer up a bullish view on European banks, arguing both the Euro markets as a whole and the banking sector are oversold, and that current gloom regarding macroeconomic data is likely to dissipate in the face of improving data through the end of the year.

European markets oversold

The overview of the report emphasizes the current oversold condition of the European banking sector. “The recent underperformance of both Europe and its banking sector looks tactically overdone and not warranted based on current relative EPS trends.”

The MS analysts highlight that the MSCI Europe index is down 4% from its June peak. They point out another 2% drop would take it back to strong technical support at its 12 month moving average.

Overall, Secker et al. argue the current pullback is overblown and not warranted by the economic fundamentals. “While Europe’s recent drop looks small in absolute terms, relative to global equities it has been very significant – e.g. MSCI Europe’s relative performance to MSCI World is now 3SD below its 12m moving average. On this metric the severity of Europe’s recent underperformance is greater than that seen during either the global financial crisis of 2008/09 or the Euro zone sovereign debt crisis of 2011/12.”

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European banks: Negative outlook based on weak macroeconomic data

The second leg of Secker et al’s bull thesis for European banks is that the current equity market doldrums are caused by weak current macroeconomic data that is likely to be revised upwards over the next few months. They say: “Our economists do not believe that Europe is about to see a renewed wave of economic disappointment – over the last few months they have revised their GDP forecasts up rather than down.”

Euro firm earnings still look reasonably strong

The report also argues the underperformance of European equities is not caused by poor earnings trends. They point out that Europe’s net earnings revision “is at the top of its 2-year range, albeit still in negative territory at –4%.” The MS analysts also highlight the fact that Europe’s 12 month EPS estimates “are no longer falling relative to global peers”.

They say that although earnings revisions may decline from here given seasonality trends, they anticipate any decrease to be more modest than seen in prior quarters, and that European companies will see increasing earnings in the second half.

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Source: European Banks Oversold As Hedge Funds Capitulate