Ukrainian soldiers in position during the Russian shelling of the town of Irpin
Ukrainian soldiers in position during the Russian shelling of the town of Irpin © Diego Herrera/Europa Press/dpa

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European stocks have tumbled in the 12 days since Russia invaded Ukraine, upending bets on a comeback this year as investors grow increasingly convinced that the fallout from the conflict will put a brake on the region’s economy.

The outbreak of war has sent shockwaves through equity markets across Europe, with the continent’s Stoxx 600 index sliding by 8 per cent since the crisis began. Investors, who worry that the resulting jump in oil prices will hammer consumers in a region heavily dependent on energy imports that was already grappling with the highest inflation in decades, last week pulled a record $6.7bn from European stock funds.

The selling intensified on Monday following reports that a western embargo on oil imports was being considered, sending European gas prices to record levels.

“Europe is probably already in recession,” said Luca Paolini, chief strategist at Pictet Asset Management. “Consumers aren’t going to go out and spend the savings they’ve built up when there’s a war happening on their doorstep, and that’s before you consider a big increase in inflation.”

The setback for European stocks — which saw Germany’s flagship Dax index enter a bear market this week, having fallen more than 20 per cent from recent highs — contrasts with the US S&P 500, which is little changed over the period.

“We were always dubious about the consensus view that Europe was due a very strong growth rebound,” said Seema Shah, chief strategist with Principal Global Investors. “Now with the conflict I don’t see how you can justify an overweight position in European equities. If there’s a retaliation that results in cuts to energy supply I think that has very serious ramifications for European industry.”

Line chart of % change since Russia launched full-scale invasion of Ukraine showing European shares slide

The war in Ukraine is “a global stagflationary shock, with Europe being the most exposed region”, said Chris Keller, Barclays head of economics research. UBS Wealth Management on Monday cut its view on eurozone stocks to neutral, meaning it no longer recommends taking an outsize position in the region.

The UK’s stock market has fared slightly better than those on the other side of the Channel, benefiting from a heavy presence of energy stocks as prices for oil and gas have soared. Although the FTSE 100 has fallen 7 per cent since the invasion of Ukraine began, “the UK has found itself in a kind of sweet spot thanks to its large overweight in energy”, said Andreas Bruckner, European equity strategist at Bank of America.

Currency markets have also responded to poorer economic prospects for the euro area. The single currency has dropped since the invasion as investors have anticipated a hit to the eurozone economy which could delay the European Central Bank’s plans to tighten monetary policy, losing 5 per cent against the US dollar since mid-February to trade at a nearly two-year low of $1.08.

The disproportionate impact on Europe “goes beyond the vague concept of geographical proximity” given the region’s reliance on Russian energy imports, according to Adam Cole, chief currency strategist at RBC Capital Markets. A historic surge in European natural gas prices pushed them to about 13 times their US equivalent on Monday.

Europe’s stock market woes have been particularly painful for investors who had widely tipped the continent’s markets for a comeback in 2022. Tighter monetary policy, it was thought, would prove a boon for Europe’s many value stocks — companies that trade inexpensively compared with fundamentals such as profits or book value — while rendering glitzier US technology stocks less appealing.

Nowhere has the turnround in market sentiment been more evident than in the declining fortunes of Europe’s bank stocks, which for the first weeks of 2022 outperformed even their rivals across the Atlantic, surging ahead on expectations that higher central bank interest rates would boost margins. Since Moscow ordered troops into Ukraine, however, the Stoxx 600 bank index has fallen by more than a fifth.

Line chart of Forward price to earnings ratio showing Valuation gap between European and US stocks widens

“The growth to value rotation has stalled for now,” said Altaf Kassam, head of investment strategy and research at State Street, who said that tech stocks were suddenly back in demand now that some of the interest rate hikes priced into the market had been taken out.

“The feeling pre-invasion was that the European economy was starting to pick up steam compared with the US, but frankly that’s stopped because of this war,” Kassam said, adding that a technical recession — two consecutive quarters of negative GDP growth — at the start of 2023 was now “much more likely”.

For now, investors seem reluctant to step in and pick up bargains in Europe’s markets. The sell-off of the past two weeks means Europe’s equities are now 25 per cent cheaper than the rest of the world on a forward price-to-earnings basis, the biggest discount since the eurozone debt crisis in 2011, according to Paolini.

“That’s probably still not enough to close your eyes and buy,” he said. “When you have the first sign of any de-escalation there will be a massive rally. But it makes sense to wait because we have no idea how long this will last.”

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