War in Ukraine forces European bulls to unwind their bets

European stock indices have largely recouped losses incurred since President Vladimir Putin sent Russian troops to Ukraine. This does not necessarily mean traders are feeling optimistic.

Investors around the world say they still view investing in the European continent with skepticism, even though the pan-continental Stoxx Europe 600 now sits almost exactly where it closed the day before the invasion. The euro, meanwhile, rebounded slightly from the nearly two-year low the currency hit earlier this month, closing around $1.10 on Wednesday.

The recent rise in European stocks has been accompanied by a broader rally that has lifted US and Asian stocks, sending the S&P 500 up 5.5% since the start of the war. Many investors and analysts attributed the global recovery to bargain hunting. Some strategists have also suggested turning to equities as an inflation hedge.

Yet many investors are reluctant to fully trust European markets. With the European Union depending on Russia for around 40% of its gas, many investors decided that the potential for soaring inflation, further supply chain problems and even a recession presented too much. risks. Instead, they are moving to regions they perceive to be more isolated from war, including the United States and some emerging markets.

Many investors expected Europe to deliver outsized gains in 2022 after two years of US dominance in global stock markets. Compared to the United States, where indices are influenced by tech giants, European markets are more dominated by energy companies and banking stocks that do well when inflation is on the rise.

The war has blurred these bets. Investors withdrew $23.4 billion from Western European mutual funds and exchange-traded funds in the three weeks between Russia’s invasion and March 16, data from the flow tracker shows. EPFR funds. That’s more than twice the releases seen in the first three weeks of the early 2020 pandemic sell-off.

Investors, meanwhile, poured $40.5 billion into U.S. equity funds in the three weeks ending March 16, according to EPFR data.

James Beaumont, head of multi-asset portfolio management at Natixis Investment Managers Solutions, said his team had been forced to revamp their model portfolios.

Last year, his team allocated portfolios based on expectations of outperformance of the US market, and in particular growth stocks. At the start of 2022, they changed their bets to be more bullish on European and value stocks.

“We thought we were well positioned in January and February. Then Putin put a stop to that,” Beaumont said.

Recently, he said, his team decided to return to a neutral position vis-à-vis Europe. “We don’t think you can trade in this environment because there could be a peace deal tomorrow,” he said.

Recent surveys by BofA Global Research show that global fund managers have settled similar bets. In January, for example, 35% of net respondents said they were overweight European Union stocks, while a net 5% were overweight US stocks.

By March, the trend had reversed: 18% of fund managers were underweight European equities, according to the survey, while a net 12% were overweight US equities.

“There are all these different anecdotes that don’t inspire a lot of confidence,” said Chris Montagu, head of global quantitative research at Citi Research. Among the worrying signs, he said: Downward revisions to gross domestic product forecasts for the region.

This month, Citi economists cut their global and eurozone GDP forecasts. Economists now expect GDP growth of 2.3% for the eurozone in 2022, down from 3.3% in February. They also raised inflation expectations, forecasting that consumer prices would rise 6.5% in the eurozone over the year, from 4.6% last month.

The consequences of the harsh economic sanctions against Russia are already being felt around the world. The WSJ’s Greg Ip joins other experts in explaining the significance of what has happened so far and how the conflict could transform the global economy. Photo illustration: Alexandre Hotz

Data suggests there is little conviction in the recent global stock market rally, Mr Montagu said, with index futures showing investors expect more difficulties for the Stoxx Europe 600 and the index German DAX. Short bets against the two indices, meaning bets that they will drop, remained firmly in place, he said. “We don’t see any new long positions being established,” he said.

Investors also expect further difficulties for the euro. Data from the Commodity Futures Trading Commission shows hedge funds on a net basis continue to bet the euro weakens against the dollar.


What are your prospects for European markets?

Viraj Patel, global macro strategist at Vanda Research, advises clients to maintain bearish positions against the euro as oil prices swing and the European Central Bank raises interest rates at a slower pace than the Federal Reserve.

“The trade shock we’ve seen over the past two weeks is going to weigh on the euro,” he said. “The days when people thought $1.30 was fair value are over.”

Write to Caitlin McCabe at caitlin.mccabe@wsj.com

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