Get ready for the European stock boom, predicts Morgan Stanley’s European Equity research team. Speaking from the land of negative interest rates and the heart of populist revolt, they say don’t worry much about the shape of the US yield curve as rates rise or other signs of concern from the interest rate markets. European banks in particular, they claim, are ready to outperform their US counterparts. If only the market would share this view and discover the value.

The flattened yield curve is not cause for concern, rather it is the inversion that matters

While some investors might think the Trump top has been put in, there is one indicator Morgan Stanley analysts Graham Secker, Matthew Garman, Krupa Patel and Lillian Huang think is getting a little too much play.

As the US yield curve flattens with expected Fed rate hikes approaching – Morgan Stanley sees fully seven such events before 2018 ends — some investors have raised concerns.

Don’t worry. “Markets don’t peak until AFTER yield curves turn negative,” the March 10 note observed. Stating that there is “no reason to fear a flatter US yield curve at this stage,” they point out a flattening yield curve is natural as rates begin to rise. “Every cycle peak in equities over the last 40 years occurred after the yield curve had already inverted.”

In a world where “ultra easy monetary policy” in both Europe and Japan is leading to a steeper yield curve, the notion they advocate is that bank fortunes should improve in such a market environment.

European stock boom: Banks are a value in Europe. No really. They are.

Forget about the fact the White House recently re-affirmed its intent to revise Glass-Steagall and ignore the fact Deutsche Bank is struggling to raise capital. There are “upside risks” with European bank stocks.

European equities have a long runway, “especially Banks,” as a “reflationary impulse” is a tailwind. Political concerns have been priced into the market but “when this political uncertainty starts to fade” European bank stocks are set to outperform.

For many years now the Banks sector has been viewed as one of Europe’s key weaknesses with concerns around balance sheet strength, NPLs and a lack of loan growth. While recently announced capital raisings should alleviate concerns on the former, and better economic activity helps the quality of the loan book, we’re also seeing a slow but steady improvement in bank loan growth. Unusually, consensus EPS estimates for the Banks sector has lagged the upturn in loan growth so far (partly due to a rising share count), however better lending volumes are further evidence that sector profitability is on the up.

European stock boom
European stock boom

Europe is on sale, why doesn’t the market get it?

Based on traditional value metrics, Europe has been a bargain relative to the US. One of the reasons for this “cheap” quality was a lack of earnings growth. The markets, being a forward looking pricing mechanism, needs to recognize that “earnings now accelerating to the upside,” as Europe’s forward price / earnings multiple has fallen sharply and its discount to the US — now at its widest level since 2012.

What the markets really need is to see the value. Rising corporate activity is the tonic that might wake them up and “help crystallize Europe’s undervaluation.” Once the real value in Europe is discovered, then stock market, as well as merger and acquisition activity, will start to rise.

“Europe has started the year at its best run-rate since 2008 and we would expect this to continue against a backdrop of rebounding economic and profit growth, high business confidence and cheap, readily available financing,” the report said, pointing to corporate bond spreads that continue to tighten along with emerging markets.

European stock boom
European stock boom