European correction has room to go

European equities are bearing the brunt of geopolitical risks that are unravelling most global stock markets this summer, but the region may have to suffer further before investors are ready to jump back in.

“For the long term, I think the answer is to continue to slowly build positions on weakness,” said Greg Newman, associate portfolio manager at The Newman Group, a ScotiaMcLeod affiliate in Toronto. “But whether it is a good time to buy in the short term really depends upon the actions of [Russia’s president Vladimir] Putin.”

The Euro Stoxx 50 is down as much as 9.2% since early summer, far exceeding pullbacks on other major indexes elsewhere around the world, including the United States and Canada, which are down less than 5% in the past couple of weeks.

Many analysts believe more losses are ahead despite a rally in stocks during the past two trading days, which have been marked by better news emanating from several political hot spots, including the border between Russia and Ukraine. Russian troops began to withdraw after an end was called to military exercises there on Friday.

“With so many hot spots out there at the moment, the winds of political change can come and go at any time,” said Colin Cieszynski, senior market analyst at CMC Markets Canada. “While we may be due for a rebound out of short-term oversold conditions over the next day or so, calling an end to the summer market correction would be premature at this point.”

This may be particularly true of Europe’s equity markets, where tensions in Ukraine threaten an already fragile economic recovery on the continent.

“The European monetary union is experiencing a summer growth scare as a result of the previous Euro overshoot,” said Arthur Salzer, chief executive at Northland Wealth Management.

He thinks past euro strength should reduce growth by 75 basis points over

The winds of political change can come and go at any time

the next year, saying peripheral Europe will be especially hard hit since exports are already contracting.

“There is a real deflation risk in Europe,” he said. “Even in Germany, inflation is only 0.5%.”

Mr. Salzer believes European equities may rebound from current oversold levels, but isn’t ready to add exposure just yet.

“The long-term case for European equities remains valid based on superior profit growth driven by a cyclical rise in margins, but we feel this sector of the public equity markets to be too early to buy,” he said.

But Jonathan Stubbs, strategist at Citigroup Capital Markets, remains bullish on Europe despite the shortterm risks. He doesn’t see a near-term catalyst that will drive equity markets back to recent highs and beyond, but recommends investors buy on dips.

“The key question for us is whether current developments are likely to end the current economic and profit cycle, even if both have not really started in Europe yet,” he said.

“We think this is unlikely and therefore think that it is right for investors to use the pullback as a chance to raise exposure and rebalance portfolios.