In focus

What impact has the Ukraine crisis had on eurozone shares?


Russia’s shocking invasion is having devastating consequences for the people of Ukraine. Where the invasion and the West’s response ultimately lead remains highly uncertain.

From an investment standpoint, eurozone shares have so far lagged other markets since the invasion.

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The underperformance of the eurozone relative to other regions has been sharp and swift. A partial recovery came on 9 March as energy prices eased and traders bet that EU leaders would take action to limit the economic impact of Russia’s invasion of Ukraine.

Why have eurozone equities underperformed?

The underperformance is largely due to growth fears, given the region’s geographical proximity to the crisis and fears around higher inflation. The surge in oil and gas prices is threatening a sharp rise in costs for European industry. Airlines, shipping companies, carmakers and other energy-intensive industries are notable examples.

The chart below highlights the sharp sell-off in cyclical companies (those most sensitive to the ups and downs of the economic cycle) within Europe relative to companies considered more defensive.

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Why have banks fallen so sharply?

Eurozone banks have been one of the sectors most negatively affected by the invasion. The MSCI EMU banks sector is down 17.3% since the invasion (as of 15 March).

However, few eurozone banks have significant exposure in Russia and/or Ukraine. Where there is exposure, much of it sits in local subsidiaries in these countries. This should put a cap on their losses. The banks can just walk away.

So far, share price moves in the sector to date exceed our estimates of the maximum possible loss by a factor of two to three times. These losses could delay, or even potential curtail, some degree of shareholder returns for the sector but we think this impact is already more than priced in to current valuations.

It’s important to consider other factors too, such as the path of interest rates. Prior to the invasion, expectations of higher interest rates were helping to support eurozone bank shares. Once the invasion took place, the knee-jerk reaction of the market was initially to reduce rate expectations. However, as it has become clearer that this is an inflationary shock, interest rate expectations have risen again. For a typical bank, 1% higher interest rates drives around a 25% improvement in earnings.

Credit losses (i.e. losses from unrecoverable loans) are another area of uncertainty. We should remember that many banks still carry extremely prudent provisioning buffers post Covid which means they are well able to absorb shocks.

Utilities sector faces dramatic change

Meanwhile, the future for European utilities looks very different from the end of last year. The priority for the last decade or two has been the decarbonisation of supply, to the marginal detriment of security of supply and consumer bills across Europe.

However, the next decade is likely to see a change in the balance of those priorities. This will have consequences throughout the energy market in every European country, each in its own way given their unique power systems.

There are three initial conclusions that we can draw:

  • The roll-out of renewables has to accelerate at even greater pace to support future security of supply, which will support the “green” generation developers and suppliers;
  • The market will have to bring back some “brown” sources of power in the short term, regardless of carbon emissions. This will benefit those with legacy coal and nuclear plants;
  • But any excess profits generated from these disturbed markets will sit under the cloud of potential windfall taxes as a way for governments to help consumers facing higher bills.

Carmakers face further supply chain squeeze

The invasion of Ukraine has caused significant disruption to the automotive industry. IHS (a body providing benchmark expectations for the sector) expects 2% of global volumes to be lost as a result of the war, with a mid-single digit impact on European volumes specifically.

Meanwhile, risks to the supply of input materials like palladium, nickel and neon (which is used in catalytic convertors, batteries and semiconductors) look likely to exacerbate the impact on production.

We saw a similar situation in 2021 with acute semiconductor shortages. Then, the financial strength of consumers - owing to stimulus programmes and higher savings rates - meant there was sufficient demand to drive up prices and protect carmakers’ profit margins. This time, with skyrocketing oil and gas prices, goods price inflation and poor growth prospects, it is difficult to see the same level of pricing support for the year ahead.

How have European policymakers responded?

On 8 March, the European Commission outlined its REPowerEU plans. These aim to deal with the high and volatile energy prices while cutting completely the region’s dependence on Russian gas by 2030.

Providing companies and households with affordable, secure and clean energy requires decisive action, starting immediately with price mitigation and storing gas for next winter. The case for a rapid clean energy transition under the European Green Deal has never been stronger and clearer.

There are many details yet to be ironed out. However, it is encouraging to see the region appear to take a strong stance on ensuring the security of European energy supply in the long term. 

Meanwhile, the European Central Bank (ECB) held its much anticipated monthly meeting on 10 March. The main headline was the accelerated reduction of the asset purchasing programme (APP) over the coming months. Monthly net purchases in the second quarter will slow to €90 billion as opposed to the previously guided €120 billion.

The ECB did make clear that its stance could change but this suggests the APP programme should finish by the end of June. The ECB has consistently communicated that the APP must finish before interest rates can rise. It is now possible we could see eurozone rates rise in the latter third of this year. 

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