However, we remain cautious on the outlook for European equities, given that we see five stumbling blocks that could prevent this optimistic projection from translating into meaningful upside for the market. We maintain our cautious year-end target of 325 for the Stoxx 600 (around 4% below current levels).

1)The Italian referendum: our European economists now see a 60% probability of a “No” vote in the Italian referendum on December 4th. Peripheral bond spreads have already widened by 20bps over the past week, but European equities have yet to react. As a consequence, peripheral spreads now point to 5% downside for European equities.

2)Intensifying Chinese capital flight: our Asian FX analysts argue that Chinese capital flight is now as intense as in H2 2015, pointing to an increased risk of a disorderly Chinese FX devaluation, especially if the Fed hikes rates on December 14th.

3)The risk of lower oil prices: the oil price has fallen by 17% from its mid-October peak, as the broad USD trade-weighted index has risen back above its January peak. The historical relationship between the USD and oil (R2 = 95% over the past five years) point to a fair-value oil price of around $30/bbl (significantly below the current $44/bbl) – and our FX strategists expect a further 5% upside for the USD index. If the oil price drops back below $40/bbl, this is likely to lead to renewed financial stress via widening US high-yield spreads (especially given the reduced support from low bond yields).

4)The impact of higher rates on valuations: the fact that European P/Es are around 20% above their 10-year average is due to extraordinarily low real bond yields (i.e. the discount rate for equities), according to our models. The 40bps rise in European real bond yields since the end of October has already reduced the fair-value P/E by 5%. If bond yields keep rising, this will put further pressure on equity and credit valuations. It is also likely to lead to renewed EM capital outflows and, hence, tighter EM financial conditions at a time at which EM corporate leverage is still close to its mid-1990s peak levels.

5)Trump tail risks remain: the market has focused on the benign elements of Trump’s agenda so far, but tail risk remain that these will be watered down or delayed in the legislative process – or that the less economically helpful aspects of his agenda (such as import tariffs or branding China a currency manipulator) return to the fore. 

Eoin Treacy's view

Here is a link to the full report.

In the last decade there has been almost no risk of a Eurosceptic party gaining political sway in a Eurozone country. However following years of what must feel like punitive damages arising from what can only be described as utopian lending standards electorates are increasingly ill disposed to support the status quo. 

Referenda are often more a vote of confidence in the ruling administration than the issue being debated. For Italians the prospect of making the lives of politicians easier by approving the proposed reform of the Senate must seem like a big ask when the country is labouring under a Berlin/Brussels imposed fiscal straitjacket. 

Whatever happens on December 4th, the risk associated with who eventually wins the French Presidential election is even more important and an even deeper source of uncertainty for investors. 

The Euro fell sharply over the last week and is now testing the lower side of an almost two-year range. On previous occasions, clear upward dynamics confirmed support in this area and a similar move on this occasion will be required to check momentum. 

The DJ Euro STOXX Index has so far failed to capitalise on the weakness of the currency in part due to the political risk associated with the region. It will need to sustain a move above 335 to confirm a return to demand dominance beyond short-term steadying.