Europe’s bull is looking lame

The bulls continue to run rampant in the US and their optimism has given Europe a boost. This week's new record high in the Dow sent the Europe-wide Dow Jones Stoxx 600 index to within 4% of its July peak; French and German stocks are also at ten-week highs. Can Europe keep going?

Beccie Williams of Williams de Bro points to further corporate restructuring (a key theme of the past few years) as being positive for earnings growth, which is expected to reach 9%-10% in 2007. Valuations look reasonable too. The DJ Stoxx is on a p/e of 14, while Germany's Dax is on 12.8. Citigroup is pencilling in another 10% rise in the DJ Stoxx by the year end.

Yet the outlook for Europe is clouding over rapidly. A drop in the widely monitored German business confidence index to a 19-month low and weak surveys of the services and the manufacturing sector, both at two-year lows, point to a cyclical slowdown. The housing booms in Spain and Ireland, which jointly accounted for 26% of eurozone growth between 2002 and 2006, have gone into reverse.

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The rapidly appreciating euro is threatening buoyant exports; the euro's 5% rise this year against a basket of major trading partners' currencies implies a 0.6% hit to growth after a year, according to Bank of America. And due to the credit crunch, high money-market interest rates are raising the cost of corporate debt. Such debt is already up by 1% over 12 months, according to Merrill Lynch, whose survey shows that 65% of credit-risk officers at European banks are looking to tighten lending standards.

Factor in high oil prices and a slowing US and Europe's growth is likely to be over 1% lower next year, says Malte Fischer in Wirtschaftswoche. "Few forecasters have reduced their growth projections to this extent." Nor do analysts yet seem to have factored in the increasingly likely US recession, which would bode ill, given scant evidence of Europe's economy decoupling from the US: it remains Europe's biggest export market after the UK, buying 14% of exports, says Lex in the FT.

The darkening outlook will take its toll on earnings. As Merill Lynch notes, the ratio of upgrades to downgrades is slowing. Expect a "chorus of companies saying life is getting more difficult", says Schroder's Andy Lynch. Add uncertainty over the US economy and Europe's multi-year bull run looks to be winding down.