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European equities could rally 10% on the back of historic fiscal stimulus, Morgan Stanley predicts

The EU flags are seen in front of the Berlaymont, the EU Commission headquarter on May 19, 2020, in Brussels, Belgium.

Thierry Monasse

European equities could jump 10% on the back of a historic agreement over fiscal stimulus in the European Union, Morgan Stanley said in a note Tuesday.

After one of the longest ever European summits a week ago, the 27 member states agreed to tap the markets and raise up 750 billion euros — an unprecedented deal at the EU level, which has yet to be greenlighted by the European Parliament, that has opened the door to common debt borrowing.

The investment bank believes that the recent decision is a “game changer” for Europe, in dealing with the current economic crisis, but also in erasing some long-standing fears over disintegration.

“We see scope for a further 10% outperformance from EMU [European monetary union] equities versus global peers, led by Peripheral indices (15% outperformance),” Morgan Stanley analysts said in a note. 

Europe’s STOXX 600 is down about 11% since the start of the year. In comparison, the S&P500 is only down about 1% since the start of the year.

“The European Union could be bureaucratic and that’s to be expected but I think the European recovery fund is a dramatic change, it is unprecedented in terms of its formation,” Chris Dyer, director of global equity at Eaton Vance, told CNBC’s Squawk Box Europe Monday.

He expects European equities to outperform U.S. stocks.

“What we are seeing in Europe is greater cohesion … whereas in the U.S. there is more policy uncertainty to come,” he said.

The United States is now less than 100 days away from a new presidential election.

In addition, the United States is also still grappling with the first wave of coronavirus cases and it is the country with the highest number of infections worldwide. In the meantime, some parts of Europe have reported an uptick in cases, but most countries remain committed to keeping their economies relatively open to contain some of the economic shock from the pandemic.

Irrespective of news of further fiscal stimulus in Europe, some analysts have also cautioned that the current earnings season is likely to show how difficult the current landscape is for businesses, which could impact their share price.

“Europe’s policy response has been better than the markets were expecting, as demonstrated by the agreement on the Recovery Fund, and this will be a positive driver for the region. That said, we expect a deep earnings recession and a slow recovery in the euro zone,” UBS analysts said in a note last week.

They estimate 2020 earnings to fall by 39%.

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