Leaders’ steps could drive 20% European equity rally

JPMAM economist Dan Morris says credible end to the crisis is in sight with progress made towards hitting three crucial benchmarks.

Equity markets could rally by up to 20% now Europe is seeing credible action towards a resolution for the eurozone crisis, said Dan Morris, global strategist at J.P. Morgan Asset Management.

Recent equity market movements have been based on the eurozone’s leaders’ real steps towards a resolution of the crisis, after a series of empty promises from politicians to “do everything necessary”.

“As an indicator of what the potential is for equity returns if things continue in this way, simply applying July’s market multiples, even on today’s lower earnings estimates, would mean nearly a 20% gain for the market,” said Morris.

A credible end to the crisis is now in sight as progress is made towards three crucial benchmarks, he said. Firstly, disbursement of the latest tranche of money for Greece; secondly the approval of the EFSF; and finally, a writedown of Greek debt and recapitalisation of European banks.

However, Morris acknowledged although progress has been made, the three benchmarks have not yet been reached, leaving the market vulnerable to further disappointments, and it is still unclear how much capital is needed to bail out the banks, and who will provide it.

“Additional support from the ECB will be important as the EFSF by itself is not large enough for the expected recapitalisations and additional purchases of peripheral country debt,” he said.

Morris backed the European Central Bank’s move to boost liquidity levels, but at the same time criticised it for lacking the courage to slash interest rates.

On fixed income, Morris said the Bank of England’s injection of an extra £75bn into the economy should help keep gilt yields lower. However, at 2.5% in comparison to 3.5% in 2009, there is little downside for further declines, he added.

“By opting for further monetary stimulus, the Bank of England is sacrificing its inflation goals (ostensibly a target of 2%) for economic growth,” he said.

When investors accept inflation in the UK will be higher for longer than expected, yields will start to reflect this, he said.