Sharp swings in stock prices are often a signal of investor uncertainty and volatility. It’s not until things settle down and stocks establish some price direction that we can get a sense of whether it’s recovery or reaction.
The STOXX Europe 600 index just had one of those stretches. After declining around 12% over a roughly one-month period, the index shot higher by 3.9% on April 8. As of April 14, the index is back to within 2% of its highs.
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Which one is more reflective of the state of the markets, the sharp decline or the quick recovery? If it’s the latter, is this a sustainable uptrend?
Image source: Getty Images.
The Stoxx 600 index fell 12% earlier this year as the Iran war pushed energy prices much higher and raised inflation fears.
The April 8 rally was in reaction in the sense that it calmed some of the market’s worst fears.
Given the rapid change of geopolitical conditions, investors probably aren’t feeling certain that this is all behind us. That makes this rebound tentative.
There are still the issues of longer-term inflation risk and the economic impact of higher energy prices.
The Strait of Hormuz is still blocked, which means energy prices could keep going higher despite the ceasefire.
The problem I have with the strength of this rebound is that the underlying issues that caused the correction haven’t been resolved.
The original ceasefire agreement gave the markets the impression that a more complete resolution could be achieved during the two-week window. But the ceasefire proved to be tenuous. Both the U.S. and Iran threatened further action. Israel attacked Lebanon. The situation appeared to get better in image only.
The markets understandably rallied from this because it at least represented an improvement, but let’s look at the reality of the situation today.
Talks for reaching a long-term resolution have been on and off and have so far been unsuccessful.
The Strait of Hormuz remains blocked. Both Iran and the United States are claiming blockades.
Energy-linked inflation rates have already gone much higher.
Brent crude oil prices are still hovering near $100 per barrel, up from around $72 at the end of February.
A relief rally based on the ceasefire was understandable. A sustained rally doesn’t seem justified.
In order to turn this into a market recovery that has the potential to establish new highs, a few things need to happen:
A reopening of the Strait of Hormuz that allows free passage for oil and cargo freight vessels, pulling energy prices back down
The return of annualized inflation rates back down into the 2% to 3% range
The markets pricing out the possibility of central bank rate hikes to address inflation
Corporate earnings that are able to hold up despite Q1’s higher costs
Once those are in place, I believe the market can return to pricing based on macro fundamentals, including earnings, GDP growth, and unemployment.
If you’re considering an investment in European stocks, three of the biggest Europe-focused ETFs are the Vanguard FTSE Europe ETF(NYSEMKT: VGK), the State Street SPDR EURO STOXX 50 ETF(NYSEMKT: FEZ) and the iShares Europe ETF(NYSEMKT: IEV).
Metric
VGK
FEZ
IEV
Expense ratio
0.06%
0.29%
0.60%
1-year return
32.5%
30.1%
31.7%
Forward P/E ratio
16
13.8
15
Dividend yield
2.8%
2.6%
2.8%
Coverage
All-cap Europe
Megacap Eurozone
Large-cap Europe
Data sources: Vanguard, State Street Investment Management, iShares. P/E = price-to-earnings ratio.
Overall, I think the Strait of Hormuz is the key. Once the markets and the public see that ships are passing through like they were pre-conflict, everybody can finally breathe a sigh of relief. Tensions are likely to remain elevated for a while yet, but normal commerce should reassure the markets that the economic impacts might be mitigated.
However, I don’t think the current market rebound from the recent lows is locked in. There may still be hope that a long-term resolution is near, but stock prices appear to have gotten a little ahead of themselves.
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David Dierking has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
European Markets Surged 3.9% on Ceasefire News. Does That Move Reflect a Genuine Recovery or a Short-Term Unwind? was originally published by The Motley Fool
