Despite negative equity expectations heading into 2023, the first month of the year ended up with gains. Weakening inflation, lower commodity prices, and on top of that, a calmer bond market all helped drive stocks higher.
Expectations are shifting fast and one of the questions arising is whether European markets are able to outperform the US. China reopening, as well as a hot winter, changed economic forecasts for the year, yet the same reasons that mattered in 2022 can still act as a differentiating factor.
Energy and commodity prices
Winter in Europe has been milder than expected with temperatures above their normal range. This pushed gas and energy prices lower, easing the strain on the continent. Analysts have been issuing dire predictions throughout 2022 mainly because many European countries are dependent on energy imports.
According to easyMarkets, one of the leading online brokerages, there is a negative correlation between stocks and energy prices. As a result, if energy doesn’t become expensive again in 2023, stocks do have a reason to continue higher and even outperform the US, given valuations are more attractive. Traders should monitor this factor closely since companies in the energy sector expect supply issues to persist until at least 2024.
For the first time in decades, Europe had to cope with war last year. The conflict came at a time when there was an interdependency between Russia and Western European countries, which pushed economic expectations lower.
While the war will soon reach a year since its start, traders and investors are no longer focusing on this variable. It turned into a protracted war and if no major escalation occurs, prospects for stocks might continue to favor the upside.
On the flip side, an agreement to end the conflict does not seem to be in plain sight. Based on current demands, Russia and Ukraine can’t find a middle ground. Moreover, it is yet to be seen whether new sanctions are imposed and if Russia responds militarily to the latest weapons deliveries from the West.
A third factor that can influence European stocks throughout the year is monetary policy. The ECB is trailing behind the Fed with its interest rate hikes. While in the U.S. rates are expected to peak during the following months, in Europe the central bank already delivered guidance for a few more solid hikes.
Based on last year’s performance, stocks are sensitive to interest rates because the market needs to discount future cash flows based on the present value of money. That leads to a “higher rates – lower stocks” dynamic.
Ironically, interest rate markets seem to ignore central bank guidance, calling peak hawkishness sooner. Moreover, the future path of interest rates will also depend on inflation dynamics. In case inflation picks up again and markets need to price in new hikes, that will be negative for stocks. Conversely, persistently weak inflationary pressures will act as a catalyst for new liquidity pouring into shares.