Morgan Stanley's equity strategists are signalling a possible tactical pause for the recent European market rebound, arguing that investors are likely to wait for clearer signals on developments around the Strait of Hormuz and for incoming company earnings to provide fresh direction.
Earlier this month the bank reverted to a constructive medium-term view on European stocks after the first signs of de-escalation emerged in the Middle East. The strategists say their medium-term bullish stance remains intact, but they also note that "investor sentiment has come a long way."
According to Morgan Stanley, the market's de-escalation rally initially favoured quality growth sectors and has more recently broadened to include momentum laggards. The team describes that pattern as a late-stage tactical signal rather than a sustained structural shift.
One of the metrics the bank highlights is the EU Cyclicals versus Defensives ratio, which it says has recovered roughly 80% of the losses recorded since the start of the year. That recovery, Morgan Stanley argues, has largely unwound not only rotations tied to Iran-related concerns but also moves linked to AI-related disruption.
On geopolitics, the strategists led by Marina Zavolock write: "We continue to expect a resolution to Middle East disruptions but reiterate that the reopening of the Strait may take time." They also point out that, contrary to a common investor assumption, European consensus earnings growth has been moving higher rather than lower amid the disruptions tied to the region.
Morgan Stanley provides a calibration for how oil prices feed into earnings: a $90-per-barrel oil price is estimated to equate to about 10% European EPS growth, with roughly 70% of that effect driven by the Energy sector. The bank notes that this dynamic is similar to the pattern seen in 2022.
Market breadth and relative performance are also in focus. The S&P 500 has returned to record highs, while the Euro Stoxx 50 and MSCI Europe remain around 3-4% below their peaks. Market commentary commonly attributes that divergence to Europes higher energy dependence and smaller technology weightings, but Morgan Stanley's strategists suggest that the near-term choppiness in European indexes has "more to do with sentiment than earnings."
Looking ahead to earnings season, the bank expects stock-level dispersion to increase well above seasonal averages. That environment, they argue, will favour a shift back toward bottom-up fundamentals - moving away from broad rotational squeezes and toward a rebalancing into defensive sectors.
In terms of sector-level earnings skew, Morgan Stanley sees the largest likelihood of beats in Energy, Utilities, Banks and Telecoms. By contrast, the biggest skew toward misses is expected in Luxury, Autos and Staples.
Takeaway - While Morgan Stanley retains a constructive medium-term outlook on European equities following initial signs of Middle East de-escalation, strategists warn that sentiment-driven gains may pause as the market waits for clarity on the Strait of Hormuz and the results of company earnings. The bank anticipates rising stock-level dispersion and a tilt back toward defensive sectors during the upcoming earnings period.