Morgan Stanley sees a 10% fall in European stocks this summer — and reveals how to trade it

Published Tue, Jun 6 202312:32 AM EDT

Morgan Stanley expects a 10% slump in European stocks over the next quarter as several unfavorable conditions converge. The investment bank made the forecast partly based on a slowdown in economic momentum and tighter liquidity conditions in the fixed-income market. "We expect a 10% correction over the summer months as growth slows and liquidity deteriorates," said Morgan Stanley strategists led by Graham Secker in a note to clients on June 4. The MSCI Europe Index is up 11% this year. A correction would take the market back to November 2022 levels. The investment bank said defensive stocks were better suited to navigate this anticipated downturn over cyclical stocks. It recommended maintaining "overweight" positions in luxury goods, medical technology, semiconductors, and software, while downgrading financials to neutral due to macroeconomic headwinds. Bounce back However , the Wall Street bank also expects the market to quickly bounce back from a downturn. Its new 12-month target for the MSCI Europe index is 8% above the present levels, which could lead to returns of over 10% when dividends are included. In addition, Morgan Stanley expects a decline in earnings per share of 6% for 2023, up from a previously projected 10% decrease, and EPS growth of 6% for 2024. LYY5-DE 1Y mountain The investment bank's strategists warned that despite the resilience of equities so far this year amid slow growth and tightening monetary policy, the environment could turn less supportive in the near term. First, even as investor sentiment remains low, their portfolio positioning remains "normal," which adds downside risk, according to the strategists. They also pointed to concerns in the macro data. The ongoing slide in commodity prices has reinforced the bank's economists' projections for GDP growth to slow materially over the next couple of quarters. Moreover, the bank said stocks are expected to grapple with a stronger U.S. dollar, ongoing monetary tightening, and diminishing liquidity. However, the bank said the downside risk should be limited. It highlighted that the current price-to-earnings ratio for the next 12 months stands at a relatively low 12.5, which should curb the summer correction to around 10%. — CNBC's Michael Bloom contributed reporting.