European Central Bank to cut interest rates boosting stock market sentiment

The European Central Bank is anticipated to reduce its key interest rate next week, lowering it to 4.25% from the current 4.5%, which should be beneficial for stocks across the bloc.

In fact, it appears that European companies are already on a winning streak: first-quarter profits were approximately 8% ahead of consensus, with 20% of firms surpassing analyst targets. This success spanned various sectors, including financials, manufacturing and materials, pharmaceuticals, semiconductors, and utilities. As a result, analysts are scrambling to revise their earnings forecasts for the current quarter upwards.

Business sentiment surveys have also become more positive this year, and inflows into European stocks have recently surged, especially in the past few weeks. However, this influx of money has mostly lagged behind the improvement in sentiment, both in terms of size and speed.

It is not entirely surprising that Europe has some catching up to do with investor sentiment. In recent years, it has been the least favoured region for buy-and-hold funds due to several well-documented reasons – the Ukraine war, the energy crisis, high inflation, high interest rates, and a period of lacklustre growth. Cumulative inflows into the region have been close to zero since 2020, making it the worst-performing region in this regard.

However, with the anticipated turnaround in Europe’s economy, there is an increase in buying into stock sectors that tend to perform well when the economy is thriving. According to Goldman Sachs, this buying is coming from major investment funds, both domestic and international.

With the Stoxx 600 market trading at a 13.5x forward price-to-earnings ratio and offering a 3.4% dividend yield, Europe is currently trading cheaper than Japan, Asia, and, of course, the US. This is quite attractive if you believe the bloc’s economy is set to recover, its inflation is under control, and its interest rates will soon start to decrease. However, be aware that the euro might lose some of its strength as the ECB cuts interest rates, because the resulting lower yields will be less attractive to international savers and investors. Therefore, if you are looking to invest broadly, for example with European stocks ETFs, a “hedged” version that mitigates the currency impact may be the better option.

JPMorgan European Discovery Trust plc (LON:JEDT) is an investment trust company. The Investment Trust JEDT objective is to achieve capital growth from a portfolio of quoted smaller companies in Europe, excluding the United Kingdom.

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