Morgan Stanley (NYSE:MS) is bullish on Europe, setting its 2014 target for the MSCI Europe Index at 1350, up seven percent from its current level of 1264. Morgan Stanley analyst Matthew Garman expects European EPS growth in the 9–10 percent range, and an overall ‘return to normalcy’ as the recovery continues and developing markets regain the ground they’ve lost since 2008. If central banks decide to extend monetary accommodation longer than most people expect, the index could go up by nearly a third.

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Earnings per share growth

The best scenario, what Garman calls the ‘Goldilocks Redux’, is that Europe manages to hit 15 percent EPS growth for the next two years, “reflecting a moderate pickup in economic activity and continued aggressive policy accommodation from central banks,” he writes. The bull case target of 1654 assumes a price-to-earnings ratio of 13.5x in the next 12 months.

The base case, ‘DM Normalization,’ would have Europe EPS growing at 9 percent and 10 percent over the next two years, “reflecting a return to normalcy in the DM macro outlook. DM economies continue their recovery while unconventional monetary policy fades and bonds yields drift higher,” writes Garman. The base case scenario has a MSCI Europe Index target of 1380 and a next-twelve-month P/E of 12.5x. Accommodative monetary policy will probably last longer in Europe than in the U.S., which could start tapering within the next month; it is still not likely to last through 2014.

MSCI Europe Index bear case

The bear case assumes that European earnings fall 5 percent and flatten out in 2015. There’s plenty of reason to be optimistic on Europe, but the recovery is still fragile and the system may not be able to handle another shock (like surging oil prices following a U.S. strike on Syria gone out of control, as the example of the moment). The bear case would see the MSCI Europe Index drop to 971 and next-twelve-month P/E of 11x.

MSCI europe index target scenarios

Garman determines his actual price target—the probability weighted average—by giving the bear and bull case a 20 percent weight each, and the base case a 60 percent weight, giving the 1350 target with 7 percent upside.