3 reasons why European markets are underperforming peers

§ 01 Executive Snapshot

• What: European equities have underperformed global markets by 7% since the start of the Middle East conflict.
• Who: Analysts at Goldman Sachs and the European Central Bank.
• Why it matters: The underperformance highlights vulnerabilities in European markets related to energy dependence, rising interest rates, and limited participation in the AI-led market rally.

§ 02 Key Developments

• European equities are negatively correlated with energy prices, bond yields, and tech outperformance according to Goldman Sachs.
• The European Central Bank has increased the policy rate by 25 basis points, which is contributing to tighter financial conditions.
• Tech accounts for only 10% of the European benchmark, limiting participation in the AI-led rally that has boosted global markets.

§ 03 Strategic Context

• The Euro area is a net energy importer, making it sensitive to disruptions in global energy prices, particularly from the Middle East conflict.
• European markets are facing downward pressure from inflation and expectations of sustained high interest rates, impacting equity valuations.

§ 04 Strategic Implications

• The rising cost of energy and tightening monetary policy could lead to increased margin risks for European companies, potentially compressing equity multiples.
• There may be a marginal improvement in European equity performance if Brent crude prices stabilize around $90/bbl in Q4 and if central bank tightening eases.

§ 05 Risks & Constraints

• High energy prices pose a significant risk to European equities, particularly for sectors sensitive to gas prices such as Germany and consumer discretionary.
• Competition from U.S. and Asian markets in the tech sector may hinder European equities' recovery and growth potential.

§ 06 Watchlist / Forward Signals

• The convergence of Brent crude prices towards $90/bbl in Q4 could signal a potential improvement in market conditions.
• Upcoming central bank policy meetings will be critical in determining the trajectory of interest rates and market sentiment towards European equities.